The can’t pay/ won’t pay conundrum
When, on the other hand, a customer of sufficient means to meet their debt obligations chooses not to, the lender must seek to adjust the customer’s attitude towards repaying the debt, rather than adjusting the repayment terms. Now, in the old days, lenders used to think that the best way to change a reluctant payer’s mind was by increasing the level of aggression - he who shouts loudest, gets paid. But, as we heard in episode seven of How to Lend Money to Strangers, more and more lenders are realising that better processes attract more payments - he who makes collections easier, through online portals and customer-focused design, gets paid first.
Risk-based collections and the 3Ts
That’s why, as in all areas of credit risk strategy, we should always be looking for ways to use data and analytics to create risk-based strategies in collections. In episode seven of How to Lend Money to Strangers I speak to Terry Franklin, who’s built the second half of his career on risk-based collections and I won’t try to match his expertise here, instead, you can treat this article as a quick introduction to the thinking that should underpin your first efforts
A risk-based collections strategy starts with the core belief that the decision to take any action should be informed by a mini cost-benefit trade-off; and that since not all customers will respond equally to any action and not all responses are equally valuable, a one-size-fits-all approach to debt management will always generate cases where too much is invested in collecting a bad debt alongside cases where a more effective approach would have been worth the extra spend.
Risk-based pricing
This situation is doubly problematic as it doesn’t only lead to sub-optimal profit but also to a sub-optimal portfolio structure. The lowest risk customers (who are being over-charged) can be tempted to leave for cheaper competitor offers while the higher risk customers (who are being under-charged) will gravitate towards your product; leading to a riskier portfolio on average. Risk-based pricing addresses this by lowering the rates charged to low-risk customers and raising the rates charged to high-risk customers.
The key to successful risk-based pricing is, not surprisingly, a good understanding of risk so scorecards are once again at the heart of any strategy. But now we’re not thinking in terms of a binary approve/ decline decision. Instead, we’re thinking on a near-continuous spectrum where we accept everyone at the right price (only declining when the ‘right price’ is too high to be legally, ethically, or otherwise acceptable).