The principles of responsible lending became popular after the infamous United States subprime mortgage crisis which occurred between 2007 and 2010 but had been introduced earlier in some countries like the United Kingdom. The crisis itself was caused by sharp decline in home prices but made worse by a housing bubble driven by the proliferation of subprime mortgage loans. Loans are classified subprime when offered to individuals who ordinarily do not qualify for loans at prime rate typically because of bad credit history. Though expensive, subprime loans are good when used responsibly because it increases the opportunity of home ownership. Subprime loan is a problem in the absence of responsible lending. Many countries adopted the principles of responsible lending to prevent consumers against over-indebtedness, typically caused by predatory lending practices but some lenders have gone further to adopt responsible lending principles as a credit risk management strategy.
Credit risk is the inherent risk of a borrower (in this case an individual) defaulting on his/her loan obligation. Loan losses happen when a borrower fails to make payments on loan instalments on the agreed dates in a term loan or fails to make minimum payments on his/her credit card on the due date. These losses range from the opportunity cost of funds utilization through cost associated with recovery to outright loss on unrecovered funds. Credit risk management is therefore a priority for banks and non-bank lenders, and it starts with responsible lending.
So, how do you SEE your customers? SEE, is used as an acronym for Suitability, Eligibility and Education.
The suitability of a loan to a borrower depends on his/her need at the time of applying. The first responsibility of a lender is to match that need to its product offering. In the Nigerian context, a simple example of an unsuitable loan is selling an expensive unsecured loan to a customer who needs to buy a property. Another example is a mismatch in the loan tenor for the purpose of maximizing revenue; this instance may lead to what is known as a repayment fatigue. In fulfilling its responsibility of selling suitably, a lender must design its processes and/or train it’s sales agents to identify customers’ needs before offering the loan. Without such processes above or the necessary training, the risk of default due to mis-selling becomes high.
The eligibility of a customer relates to affordability of loan repayments, having the appropriate source(s) income and/or stability of the income source. Eligibility must be determined at the point of sale and approval of the loan. As a responsible lender, your loan product must have a well-defined eligibility criterion (based on risk appetite) that guides both the sales team and loan underwriters. Also, key to loan eligibility is KYC (Know-your-customer) guidelines which prevents fraud and ensures that the loan is disbursed to the person identified as applicant. The idea behind eligibility of a loan is not a set of rules that have been created and passed down to the sales team but more important a credit risk culture that spreads across the organization. Eligibility assessments may be automated as part of your loan process, into an application score card and it typically requires completion of a form containing demographic and financial information. Non-eligible borrowers are more likely to struggle with repayments or even default outrightly.
Loan defaults can also be associated with how poorly educated the customer is on the loan features. It is not enough to assume that customers are aware of the interest rate, repayment dates, settlement charge, loan tenor and other features because it was agreed during sales. As a responsible lender, these features must be captured on the offer letter or loan contract and possibly explained clearly to the customer verbally. More recently, technology has made it easy to communicate with loan customers via email, short message service (sms) and a client portal. There are several communication touch points in a loan cycle that must be well utilized; at point of sales, pre-disbursement and post disbursement. Post disbursement, a lender may send repayment reminders a few days before due date to reduce the risk of default.
Most of the points discussed so far relates to onboarding and management of the customers but SEE can also help a lender with remedial management. In the event of default where it becomes necessary to restructure a loan, these principles are required of a responsible lender.
Today we see local financial services companies in Nigeria adopting responsible lending principles as a tool to protect their organizations from reputational risk but evidence from countries that have adopted it shows that it also serves in managing credit risk.
- Gboyega Adelowore
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