Lenders are ready

22nd June 2022

Unlike previous times of economic uncertainty, most providers of finance are well prepared for the impact of higher interest rates and cost-of-living increases

When I wrote about rising inflation six months ago, little did I know that my prediction would appear to be somewhat on the low side.

At the time, I saw prices rising to four per cent ‘or more by the second half of 2022’. Now, I can see that my ‘or more’ should have read ‘considerably more’.

Even without the invasion of Ukraine, the UK was looking at inflation hitting six per cent by the Spring (source: Bank of England). Now that we have the long-feared Russian aggression, and what looks like the phasing out of European dependence on its energy, who knows what the Consumer Price Index is going to be by the end of the year.

Given the number of variables at play, even the most reliable of sources is going to find it difficult to predict. 

Most though would put money on it being a lot closer to ten per cent than is comfortable. 

For lenders, such a high inflation scenario should cause some concern. For, where inflation goes, interest rates invariably follow. And there is obviously a well-established link between higher interest rates, testing economic times, and the incidence of late payment and default, particularly for those with variable rate finance. 

The further north the interest rate goes, the greater the level of grief for any lenders’ loan book. 

Financial markets were pricing-in four interest rate rises for 2022, taking the Bank Base Rate to 1.25 per cent by year end, before Ukraine. Given the conflict in eastern Europe, we are going to have to consider that, like my inflation prediction of last year, there is a risk that this could fall some way short of the mark.

I know the Bank of England has suggested that the Russian invasion may delay its rate rises, however, if inflation persists, it is bound to hike them in line with its mission to keep inflation under two per cent.  The interest rate rises will come later, but they will still come. 

UK borrowers used to a long period of ultra-low interest rates, may be looking at a BBR of two per cent or more by the end of the year on top of all the other escalating costs. 

Two per cent may prove to be a worse case scenario, but whatever happens during the coming months, lenders are going to be moving into waters they have not navigated for the best part of twenty years. British borrowers have become used to stable rates of under 0.75 per cent. You have to go all the way back to 1988-90 and 2003-7 to find periods when interest rates increased sharply from a low base. 

Then – in line with all previous periods of higher and rising interest rates – many borrowers struggled as their monthly payments grew. Aggregate default rates rose. The cost to lenders varied according to the quality of the loan book and ability to handle the changing situation. For a few the rising adverse lending was fatal for profits, for others less so, but for all these were unsettling periods. 

This time around, thankfully, lenders small as well as large, are in a far better position to ride out the impact. 

Technology, undreamt of at the turn of the 21st century, will allow them to weather such stress tests.  Where analogue processes in the 1990s meant meaningful data was to all intents and purposes unobtainable, fintech suppliers such as LendingMetrics now mean that it is easily accessible and in an instant. 

Plug-and-play automated platforms, such as ADP and LMX, enable lenders to precisely calibrate the level of risk they are willing to take with every single applicant. A risk that they can scale up, or down, according to the changing environment. And, because they can take a granular view of each applicant and obtain a real-time insight into their activity, lenders are less likely to make poor lending decisions.

Ideally, the turbulent times we are entering require lenders to be able to recalibrate their affordability assessments for individual applicants on a quick and constant rolling basis. What someone can afford yesterday, is not necessarily what they can afford today when their circumstances are more prone to change. With this in mind, regulators are driving in the direction of ever more demanding tests of a consumer’s ability to satisfactorily meet their loan commitments without causing hardship.

This will be the first period of significant economic uncertainty when lenders will have tools at their disposal to make such assessments in levels of detail previously unheard of. Real-time automated access to transaction and multi-bureau data will enable recalibration to take place from one second to the next. 

Furthermore, the technology will make loan book management a far more exact science. Lenders can tap into data feeds that, when authorized, can be used to automatically track spending habits and pre-warn underwriters when borrowers are on course to miss payments. A single pre-emptive telephone call while the borrower is still able to meet their commitments can be used to reschedule a loan, rather than the usual situation of having calls ignored after they fall into arrears.

In general, lenders will have access to data and analysis that will guide them to making optimal decisions, both in terms of new and existing business, and in terms of regulation… Tools that they would only have been able to dream about twenty years ago.  

David Wylie, Director at LendingMetrics