The mispricing of risk in consumer credit is a threat to all lenders, particularly those that lack flexibility.
Years of low interest rates and fierce competition in the UK credit market has created a price war. Lenders are using cheaper loan products with wider consumer appeal to retain existing customers and capture new market share. This is a dangerous game and is leading to inadvertent mis-pricing of risk in the race to attract customers.
At first glance, however, the market fundamentals look sound. Figures from the Bank of England show strong growth across all credit asset classes. In the last quarter of 2017, ‘Residential investment’ (mortgages) grew by 10.1% on the previous 12 months. In the same period ‘Average arrears’ continued to fall – suggesting a buoyant market with high confidence in both borrowers and lenders. In the year to March, the entire consumer credit category grew by a more-than-healthy 8.6%.
But there are also warning signs, principally from the figures relating to the cost of credit. Except for credit cards, the Bank of England’s figures paint the same picture across all asset classes: it’s getting less and less expensive to borrow money. As this trend continues and the number of high-risk-cheap-credit customers spikes, inevitably, an adjustment must occur. Defaults will rise and, to compensate, the pricing of risk must do the same.
Lenders agree: a straw poll at a recent Equiniti Credit Services event revealed that 83% believe the market is mispricing risk.
What’s more, the future is becoming increasingly tough for lenders to predict because the market dynamics are changing dramatically. Equiniti’s research into the UK’s credit landscape confirms a seismic attitudinal shift among the UK’s borrowing public. Nearly half the market (47%) is now prepared to borrow from an unfamiliar lender. A massive 83% of consumers now research loans using a price comparison site. Just 18% of consumers want direct contact with their lender (down from 77% in 2014). Consumers are becoming distant. Brand loyalty is evaporating. Decisions about lenders and their credit products are being made on price alone.
They say, ‘age is the price of maturity’. But if today’s lenders want to last the distance they must take the mature view today. If a market adjustment is ahead (and, surely, it is), lenders must have the agility to respond quickly to that adjustment. Knowing that customer attitudes are on the move isn’t enough. To continue to prosper, lenders need to understand how they are changing and what they must do to keep them. This means taking a data-led approach and embracing systems that deliver real-time customer insight. It means freeing up internal resources and offloading non-core activities to specialist partners to enable fleet-of-foot operational change. The longer the mispricing of risk continues, the bigger the adjustment will be and the harder the industry will be hit.
Getting the house in order now while the going is good isn’t just sensible, it’s essential. For some lenders, it could be the difference between continuity and crunch.
Sarah Jackson, Director, Equiniti Credit Services