By Misha Rogalskiy, co-founder of Koto
Taking out a loan should be a useful part of managing money, but the way the market has shifted over the last few decades has meant that many, especially younger, people are cautious about borrowing.
Lenders should only be granting credit to consumers who can repay it without excessive difficulty, and consumer credit or related products should be built to meet the needs of the consumers they target. To do this, creditors need to have a deep understanding of their customers, one that goes beyond a simple credit rating, which can ignore important factors impacting individuals’ financial situations.
With this in mind, individuals in the “near prime” or “thin file” category, who could be recent immigrants, graduates or people with a financial blip in their very distant history, can often struggle to secure credit. This may mean they turn to the lenders on the periphery of the industry with confusing, ever-changing fee structures; or payday loan providers. Advantageous lending strategies such as these have meant many consumers avoid borrowing unless it is absolutely necessary.
In this article I will talk through why the lending market is in urgent need of a shake up – to bring out offerings that work for the individuals who may currently be excluded by mainstream lenders. Lending is a key part of the UK’s economy and it’s vital that consumers and lenders understand each other. This is of paramount importance when it comes to maximising the benefits for both parties involved.
Incorporating a predictability model
Credit scores were invented in the 1950’s – before that, creditworthiness was judged based on a person’s character. Credit scores soon became a key tool used by lenders and banks to ascertain the risk of lending to a consumer, but were not used in a standardised way as they are today, with some lenders not using them at all because they were considered too costly. Then the financial crisis hit in 2008 and with it the Consumer Credit Directive, which had a primary objective of ensuring consumer credit regulations across Europe were consistent, boosting consumer protection against irresponsible lending.
One of the Directive’s key provisions was to: “oblige [EU] member states to ensure that creditors assess the consumer’s creditworthiness before the conclusion of the credit agreement and before any significant increase in credit.” In short, prior to proceeding with a credit agreement, lenders need to predict whether or not the borrower will be able to repay without experiencing excessive financial hardship or determine if the lending is not suitable for the consumer’s needs and current circumstances.
A couple of years later however, a review conducted by the Office of Fair Trading (OFT) found that not much had changed, with many people still being given loans they were unable to afford. When unable to repay, some lenders would encourage them to extend, worsening their financial difficulties. This resulted in the Financial Conduct Authority (FCA) warning high-cost lenders about irresponsible repeat lending that would propel borrowers into a cycle of debt.
These developments have meant that giving credit where credit is due whilst also protecting consumers from harmful debt is now a top priority both for regulators and most of the industry. The concept of affordable lending is something that the regulator and the industry has been focussing on, and firms are trying to find ways to assess applications in a way that takes into account both credit scores and alternative factors that will help them to make the right decision.
One such innovative example is that in tandem with the trusted credit check, machine learning can assess a variety of factors about a consumer to assess their eligibility for credit and likeliness to repay, generating a hybrid scoring model. Estimates claim that this could open up safe lending for 12 million creditworthy consumers in the UK who are classed as “thin file” (meaning there isn’t enough data in their credit score to judge them by) and thus may struggle to qualify for credit when they need it.
Embracing a Customer Service Approach
Some focus groups we carried out at Koto last year (March 2019) told us that the two big reasons consumers were only seeking credit at big banks, or otherwise avoiding it at all costs, was a lack of awareness and transparency. For lenders who want to give their consumers the respect they deserve, “no surprises” is a keystone approach.
Before founding Koto in the UK in 2018, I was in the founding team of Ukraine’s first mobile-only bank – centred on lending – Monobank. After just a month, we had already issued 50,000 cards and our 1 million customers milestone was reached in our first year. Today we have 2.6 million customers. How? Customer service. We didn’t have any marketing or PR budget and instead invested in listening to our customers and developing a product with features they actually wanted that worked the way they wanted. We were also able to offer more consumer friendly prices and rates, especially versus non-mobile banks. As a result, word of mouth was one of our greatest lead generation strategies, as customers organically promoted us to their friends and family.
This is a critical lesson for lenders. Firms must embrace a proactive customer service approach that alerts people well in advance if they are about to run out of credit and what they can do to avoid interest rates and spiralling into debt. Without fairness, trust and transparency, the life expectancy of any lender will likely be short and controversial.
