Macroeconomic effect on consumer finances may lead to high delinquency rates; Unsecured lending products need to be redesigned amid rising pay cuts and lay-offs;
A significant change in demand for certain retail credit products, whilst lenders take a more cautious approach due to Covid-19 situation. Macroeconomic factors and their effect on consumer finances are projected to lead to an increase in delinquency rates, which are anticipated to be more pronounced for unsecured lending products. This calls for lenders to innovate and redesign their operating models to better support consumers in these unprecedented times.
These are the findings of a report by information and insights provider, TransUnion CIBIL. The study draws on lessons learnt from the previous financial crisis to help map potential changes across the major retail credit categories. By tapping insights from the last recession and understanding what macroeconomic factors drive the shifts in consumer demand and asset quality, TransUnion CIBIL wants to ensure that lenders are empowered to plan with greater certainty and can continue to support consumers during these unprecedented times, whilst also effectively managing portfolio risk.
Abhay Kelkar, vice-president (research and consulting) at TransUnion CIBIL, explains: “Prior to Covid-19, India’s retail credit market was still growing at a much higher rate than most other credit markets around the world. However, this is a global crisis and no economy is immune. Despite the Indian government launching one of the largest economic relief packages in the world, the social, financial and economic impact of Covid-19 will be far reaching and will lead to a realignment of the retail credit market. Consequently, lenders need to respond to the changing market conditions by redesigning their distribution networks and customer management frameworks, realigning their lending strategies basis their own risk appetites, and implementing analytics-driven risk and collection management practices to minimize the impact of emerging risks.”
The study looks at how the lockdowns implemented to curb the spread of the virus, and the virus itself, have had far reaching implications. It acknowledges that consumers’ financial positions have changed dramatically, with many facing pay cuts and lay-offs. It outlines the sharp drop in consumer sentiment and the significant hit to consumption demand and spending. The research observes that the economic implications of the current crisis will have a significant bearing on the future trajectory of retail credit growth and asset quality. At the same time, it recognizes that the impact on asset quality of an individual lender’s portfolio will also depend on the risk management practices adopted by that lender, including the use of risk models and data analytics in credit underwriting, portfolio monitoring through behavior scorecards and early warning systems, and implementation of collection prioritization models.
Secured lending to see pronounced demand decline
The TransUnion CIBIL research analyzed the relationship between macroeconomic variables and credit data such as originations and inquiries for key retail credit products. By observing the changes following the 2008/2009 global financial crisis, it is possible to predict certain behaviors. The previous crisis lasted for around six consecutive quarters, and during that time both retail credit inquiry and origination volumes fell by almost 50% YoY. This drop was more acute for products like personal loans and credit cards (~60%). However, the report predicts that the fall in demand for these products in the current crisis period will not be as acute as it was during the previous crisis period and will likely be the reverse, with secured lending products seeing the more pronounced decline.
Kelkar further adds: “Unlike the last recession, we anticipate demand for products that provide much needed liquidity like credit cards and personal loans will remain moderate as consumers look to secure funds to bridge any personal finance gap. Their general availability and market penetration are much greater than they were previously. The prevalence of FinTechs has also introduced new, more flexible product structures and greater access via digital channels. Equally, because of the nature of the Covid-19 crisis, there has been an increase in the need for digital payments that credit cards facilitate well. We know that consumers are reducing discretionary spending and will have reduced affordability, as well as a diminished ability and need to travel. And we expect that demand for secured lending products like auto loans and home loans will likely remain weak for some time.”
Approval rates expected to drop
Again, using the 2008/2009 financial crisis as a benchmark, it is possible to predict a fall in the approval rates for all retail lending product categories. TransUnion CIBIL observed that the likelihood of approval rates dropping is highly correlated with the inherent risk associated with the product itself. The drop in approval rates during this time was most acute for personal loans (-30%) and loans against property (LAP) (-28%).
LAPs are typically seen as higher risk because they are popular amongst smaller business owners, and the irregular cashflow concerns presented by Covid-19 will be a significant issue. Personal loans, which are unsecured in nature and had seen increased acquisition from high risk consumers prior to Covid, also represent an increased risk of default.
Credit cards are relatively less risky because they carry a revolving credit line, which can be periodically managed by lenders, with spending and any changes in balance and behavior monitored closely. Lenders often favor home loans during periods of crisis as they are secured in nature and have a lower default probability.
“While we expect a drop in approval rates for all major retail products due to lenders likely tightening their credit policy and customer selection norms, given the inherent risk of products like LAP and personal loans, we anticipate a greater decline in approval rates for these products. Lenders are gearing up to manage and mitigate risk associated with the economic impacts of the pandemic with a cautious approach – leading to potential impacts on balance sheet growth,” says Kelkar.
Asset quality for unsecured lending to be impacted
Although TransUnion CIBIL’s research shows that delinquency rates have remained largely steady in the last two years with the exceptions of LAP, the likely impact of Covid-19 on asset quality in the coming months is a complex picture dependent on a number of interlocking factors – and as with the demand and supply of credit, varies by product category.
Shifts in asset quality during the crisis can be forecasted by analyzing: a) Consumer credit scores – shifts in borrower risk tiers across product portfolios and delinquency rates associated with each tier, b) Collection roll rates – the number of accounts becoming newly delinquent and flowing into subsequent delinquency buckets & c) Payment hierarchy – the order in which consumers prioritise payments during times of financial hardship.
The inability of some consumers to pay their debts post the moratorium period ending is likely to adversely impact their scores, and consequently the default probability may see a rise. Adherence to social distancing norms and limited field travel may impact overall lender collection efficiency, resulting in an increase in roll rates across various buckets. By simulating these risk factors related to score tier movements, it was possible to model delinquency rates associated with score tiers and collection flow rates for delinquency buckets to gauge the impact on asset quality.
Based on a historical analysis of consumer payment hierarchy, the TransUnion CIBIL research observed that when facing financial distress, consumers pay mortgages first, then personal loans, and cards are the last product to be prioritized in terms of payment obligations relative to those other products.
The writer is a journalist with 14 years of experience