Stacey West, Senior Consultant, Fair Isaac Advisors
Credit delinquency is an increasingly prevalent problem in the UK, with credit card debt growing at its fastest rate in 12 years. Both the persistent debt initiatives announced by the FCA in response to the credit crisis and the implementation of IFRS 9 this year have put card issuers under mounting pressure to help consumers claw their way out of debt.
To combat the twin challenges of rising debt and IFRS 9, UK card issuers are likely to increase the promotion of Direct Debits and offer greater flexibility to those using them. Lenders that are making payments more convenient for their customers will be the ones that successfully stave off further debt and hefty IFRS 9 loss provisions.
Under IFRS 9, issuers must provision for a 12-month expected loss for low-risk stage 1 accounts, and provision for lifetime losses on more risky accounts in stage 2. Should an account go 30 days past due or the level of risk increase since the account was opened, it will move from stage 1 to 2.
When a customer moves across stages, all their accounts moves well, so impairment would need to be taken at the lifetime level for all of them. Additionally, curing a stage 2 account does not mean its status automatically reverts back to stage 1, unless an issuer can successfully make a case for why the actual risk status of the account has changed.
A European Banking Authority impact assessment report has anticipated impairment costs could rise by up to 18% under IFRS 9, largely as a result of stage 2 provisions. To avoid a substantial increase in the funds needed for impairments, card issuers need to prioritise collection techniques that help keep accounts in stage 1.
In addition, a month after IFRS 9 came into force, the FCA introduced new rules and guidance to help customers in persistent credit card debt. Issuers will be required to monitor accounts over a 12-36-month period to determine if cardholders are paying more in fees and interest than the principal balance, and if so take action – for example, prompt customers to make faster repayments and reduce interest and other charges for delinquent accounts.
Direct Debits – a promising solution
FICO looked in detail at four clients’ data, and accounts without a Direct Debit had a bad rate (bankrupt, charge-off or 3+ cycles in the following 6 months) of between 1.5 to 3 times higher than those with a Direct Debit.
While this does not mean that all accounts that set up a Direct Debit will demonstrate improved payment behaviour, it could help those with payment problems – for example, people who consistently make late payments out of forgetfulness. This would also be in the cardholders’ interest, as they would avoid fees and poor credit information being logged at the credit bureau.
Who’s using Direct Debits already – and who isn’t?
According to the December 2017 FICO Risk Benchmarking results(see Figure 1), 37% of UK card accounts have a Direct Debit in place. For those under 5 years on book, the rate is over 45%, a figure that drops to 30% for accounts more than 5 years old. This same pattern is repeated for Classic and Premium card averages, with a higher percentage of Premium cards having a Direct Debit set up to pay their credit card balance.
Student cards have the highest overall percentage of Direct Debit users at 56%, with over 80% of accounts less than 12 months on book with one; this suggests that issuers are strongly promoting this payment method among this group.
FICO’s study also showed that consumers under 30 years of age were less likely to have a Direct Debit in place, as they might be more likely to use mobile or internet banking options instead.
Card issuers: Best practices to increase uptake of Direct Debits
The convergence of IFRS 9 and persistent debt initiatives is forcing issuers to consider how they can make payments as convenient and frictionless as possible for customers.
Although timely payments may result in a loss of revenue for issuers, such short-term losses will be far outweighed by the cost of provisioning for stage 2 accounts or the actions required in a persistent debt situation. This trade-off will help issuers build a business case for incentivising Direct Debit usage.
Ultimately, moving to a more flexible payment structure will be the most effective method to encourage more people to opt to pay by Direct Debit. Given the rise of the ‘gig economy’ and the number of people being paid weekly, offering cardholders the option to choose a date which suits them best – perhaps to coincide with payday– or even to make multiple Direct Debit payments per month, can only help those with unpredictable cash flow.
Issuers should also address the common misconception that only minimum or full payments can be taken through Direct Debit when in fact, any proportion or amount is available. They can also consider:
- General Direct Debit education programmes
- Promoting options for payments outside of just minimum or full balance
- Incentivising Direct Debit adoption with preferential offers -reduced interest rates or longer balance transfer periods, for example
- More visible promotion of Direct Debit payment options during origination stages
- Ensuring statements, and hence payment due dates, are aligned to customers’ salary dates
- Campaigns targeted at more mature accounts, those with a Classic credit card and based on consumer age
Direct Debit looks to be a win-win situation for both card issuers and borrowers – issuers will avoid the heavy costs associated with stage 1 accounts slipping to stage 2, and borrowers can avoid fees and bad credit scores. It’s down to the issuers, however, to ensure that consumers are aware of the benefits, and are offered the flexibility they need to make the right size payments, at any time.
Stacey West is a principal consultant at analytics software firm FICO. She blogs at www.fico.com/blogs.
Former Bank of England Governor Carney joins board of digital payments company Stripe
By Kanishka Singh
(Reuters) – Mark Carney, former head of the UK and Canadian central banks, has joined the board of U.S. digital payments company Stripe Inc, days after the company was reported to be planning a primary funding round valuing it at over $100 billion.
“Regulated in multiple jurisdictions and partnering with several dozen financial institutions around the world, Stripe will benefit from Mark Carney’s extensive experience of global financial systems and governance”, the company said on Sunday, confirming a report by the Sunday Times newspaper.
Forbes magazine had reported on Wednesday that investors were valuing Stripe at a $115 billion valuation in secondary-market transactions.
A senior Stripe executive told Reuters in December that the company plans to expand across Asia, including in Southeast Asia, Japan, China and India.
The company offers products that allow merchants to accept digital payments from customers and a range of business banking services.
Stripe raised $600 million in April in an extension of a Series G round and was valued back then at $36 billion.
Consumer-facing fintechs have seen a boost to their businesses during the COVID-19 pandemic, as people have been staying at home to avoid catching the virus and have increasingly been managing their finances online.
Carney, who headed the Bank of England and the Bank of Canada, had a 13-year career at Wall Street bank Goldman Sachs Group Inc in its London, Tokyo, New York and Toronto offices.
He is the United Nations special envoy on climate action and finance.
(Reporting by Kanishka Singh in Bengaluru; Editing by William Mallard)
The potential of Open Finance and the digitisation of tax records
By Sudesh Sud, Founder of APARI
The world is undergoing huge changes at the moment. Between coronavirus pushing the economy to the limit and a group of Redditors challenging the financial market hegemony, people are questioning the role of established institutions. If finance doesn’t work to enable the economy, businesses or individuals, then who is it for?
Before the digital revolution, financial experts were seen as a necessity. They knew how things worked, what everything meant, could provide good advice and were employed to sit at the heart of the action. Now, trading can be done by anyone online through established platforms, with a wealth of information available to hand.
Yet, as the 2008 financial crisis proved, established financial institutions have made themselves too big to fail. Simply tearing down the existing financial system would leave many ordinary people, along with businesses and government treasuries, in ruin.
However, as legendary futurologist, Buckminster Fuller, once said: “You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.”
Traditional banking models are already being upended by technology. Through Open Banking, challenger banks are able to connect services digitally, cutting inefficiencies and costs while speeding up transactions. Now, Open Finance is seeking to build on this model to connect financial services via technology, potentially making the existing financial model obsolete.
Just as Open Banking led to greater democratisation of money, Open Finance has the potential to transfer power back to individuals. Not only would this benefit society as a whole, but it would help minimise the boom-bust cycles that cripple entire economies. No individual would be too big to fail, and bailing people out would cost far less, having minimal impact on the economy overall.
With more information available to them, Open Finance businesses will be able to use technology to make better decisions instantly. Many people struggle to get onto the housing ladder due to a poor credit score, for example, yet they have been paying rent every month of their adult lives. Why, then, can they not access mortgages? A company called Credit Ladder is addressing this through Open Banking, reporting rent payments via challenger banks like Starling to credit agencies, helping good renters to access mortgages.
While it is still very early days for Open Finance, there seems to be an endless raft of possibilities to benefit individuals, businesses and national economies. Faster, more secure, and less risky access to credit can help grow the economy, transforming finance from something that benefits a few wealthy capitalists to something that enables growth in the real economy.
So how else could Open Finance benefit society?
Using Tax Information
Every working adult pays income tax. Some of us via self-assessment while others are enrolled in PAYE. Regardless, we all have tax records with a wealth of financial information that has been verified, at least in part, by HMRC.
This centralised repository of financial information could be put to better use, such as allowing credit reference agencies to better understand an individual’s risk profile or helping to prove income as part of a mortgage application. Unfortunately, HMRC is a black hole of information ‒ its sheer size and power sucks information in, but nothing comes back out again.
However, by Making Tax Digital (MTD), HMRC are effectively allowing individuals to keep validated tax records on the software of their choice. Software providers may then be able to use this information to enable certain aspects of Open Finance. The information doesn’t need to be protected by HMRC, it is the individual’s choice and responsibility over how to use their own information.
As MTD software develops, we will see it connected to Open Banking, allowing self-assessed taxpayers to connect their business account directly to the software, effectively getting their tax return completed for them by an AI program. They would simply check the details, add any adjustments, and click submit. HMRC would then validate the records, providing assurance for any financial institutions using that financial information.
More Growth, Lower Risk
With access to complete and validated financial information, lenders would be able to more quickly and accurately assess individual risk when considering a loan or mortgage application. This would greatly speed up the process of applying for a loan, whether for a business venture or property purchase, for example.
Take residential landlords, for example. They may own a few properties already, with equity coming out of their ears. If that landlord wants to obtain another property, they would need to get their accountant to assemble their financial information, complete a SA302, and send everything off to their mortgage advisors who would then validate the information before submitting the mortgage application.
The application can then take months to approve, slowing down the process and potentially leading to missed opportunities. Since property sales usually occur in a chain (the owner of the property you are purchasing is usually purchasing another property, and so on), these inefficiencies slow the process down for everyone and can have major impacts.
If, however, mortgage applicants could simply share validated financial/tax records, mortgage providers could use that information to make quick decisions with reduced risk. What’s more, applicants could share only relevant, high-level information, rather than expose their entire financial history.
Individual Risk Management
Currently, individuals can manage their credit score/risk profile via third party providers like Experian, Equifax and TransUnion. These credit reporting agencies use limited information, such as credit cards, store cards and loans to assess risk. Individuals need to understand what factors each agency uses in order to ‘game’ the system.
For example, someone who has always been careful with their money, kept to a strict budget and never taken out a loan or credit card will have a far worse credit rating than someone who regularly uses debt to finance their lifestyle. So, even though they may have amassed a good deal of savings, they cannot get a good deal on a loan or mortgage.
With Open Finance, these individuals would be able to quickly prove their earnings, spending, and savings, decreasing their risk profile in line with reality. Rather than crude measures of creditworthiness, financial institutions would be able to use accurate and validated information to make quick decisions based on realistic risk. This both transfers more power to individuals and contributes to faster growth while reducing overall risk.
As a centralised repository for validated financial information, MTD providers will be in a unique position to develop a two-sided marketplace for finance, allowing credit providers to match products to individuals’ risk profiles. When a customer needs a loan, credit card or mortgage, they can simply browse products for which they have already been approved, applying and receiving finance instantly.
Empowering PAYE Taxpayers
Currently, PAYE taxpayers have little, if any, visibility or control over their tax contributions. They will see the amount paid in tax and national insurance, but to claim any allowances requires them to submit a self-assessment tax return. For most PAYE taxpayers, this simply doesn’t seem worthwhile.
Yet, self-employed taxpayers can claim for things like travel to their place of work, a proportion of living expenses when working from home, even their lunch. These things are necessary for productive work yet, for PAYE taxpayers, come out of their already taxed income. Meanwhile, businesses tend to make use of every tax allowance available to them.
This imbalance could be rectified with Open Finance connected to tax software. As MTD becomes a validated system for self-assessed taxpayers, a new version could be developed for PAYE taxpayers, putting them in control of their tax and finances. Not only would they be able to benefit from Open Finance in the same way as self-assessed taxpayers, but they will also be able to claim for reasonable allowances. What’s more, HMRC/the Treasury/the government would be able to hold employers accountable for pay disparities and unreasonable tax avoidance.
Open Finance, then, has the power to speed up and reduce the cost of obtaining and providing finance. It would make the finance system fairer and most transparent while distributing financial power, and help to avoid the creation of too big to fail financial institutions and the boom-bust cycle that has become unfortunate features of modern capitalism.
Ultimately, Open Finance has the potential to help the UK and other nations recover from the seemingly unending series of crises that have plagued the early 21st century by allowing people to access finance quicker in order to grow their business and personal finances while reducing risk, inefficiencies, and costs.
Three ways payment orchestration improves financial reconciliation
By Brian Coburn, CEO or Bridge,
When Luca Pacioli, the 15th century Venetian monk, invented double-entry account keeping, managing financial reconciliations had its own unique challenges. The father of modern accounting didn’t have to deal with glitches in his book-keeping app but he did have to write with feather-based quills by candlelight. Five hundred years later the challenges are different but no less onerous.
As in the 15th century, solid financial reporting is at the heart of every successful high-transaction business. As Pacioli no doubt knew, up-to-date, well-documented accounting ensures good operational health and makes it easier to grow. And that’s never been more important.
While it might not be feather quills by moonlight, today’s environment of multiple customer channels can be time-consuming and labour intensive, with various payment methods and financial reconciliations from multiple data sources.
Understanding cash inflow through online transactions is a critical element of financial reporting. However, when these involve multiple payment processors and payment methods and a complex system of disjointed silos of payment data, this can become a cumbersome and arduous manual task.
Common issues in this fragmented payments landscape include working across different formats, managing different data owners and access as well as inconsistent process timings. The result is often increased inaccuracy and inefficiency. Procuring multiple tools and software can end up being uncost-effective and unwieldy. Though the current digital transformation is an exciting time for retailers, staying on top of the ever-changing payment options can be an overwhelming burden for many business owners.
Introducing payment orchestration presents a single, accessible, creative and accurate source of transactional data, crucial for today’s complex challenges around financial reconciliations.
Today, commerce is 24/7, so being able to access and analyse real-time information is vital to managing business controls. Many organisations have looked to automate these processes with account reconciliation software.
However, one key challenge is the sheer volume of transactions and the need to capture data from a variety of different sources. Payment orchestration enables transactions to be carried out by multiple payment processors and payment methods with simple and flexible plugins, centrally monitored and routed in the most optimum way.
It allows users to add or remove providers easily, knowing the complexity (detecting outages and automatically rerouting payments) is being handled by a trusted specialist partner via an intelligent platform.
Bringing disparate sources of online transaction data into one place simplifies how enterprises access and operate with multiple payment processors and payment methods. This makes it easier for businesses to remain agile.
For organisations that still depend on manual, spreadsheet driven processes, the mechanics of reconciliation can be extremely time consuming.
A payment orchestration layer creates the opportunity to automate processes and reduce manual intervention. By bringing multiple payment processors and payment methods into an integrated service layer with intelligent routing capabilities, the impact of individual outages or failed payments can be mitigated to ensure optimum payment success rates, saving crucial revenue.
Naturally, significant manual work brings with it the added risk of human error. The speed with which business moves today demands accurate accounting processes. Checking for error takes up valuable time that could be spent focusing on business growth.
Payment orchestration can improve accuracy and reduce the opportunity for error. Providing a holistic and central source of real-time transactional data, payment orchestration can offer improved transparency and greater visibility of financial data.
With all transactional data captured in one source, payment orchestration can present a data source to feed other applications – such as automated reconciliation tools and fraud management – automating business processes in a seamless way across the enterprise. Good practice like this will, of course, enable a consistent approach to fraud management across all channels and payment services.
Multiple payment choices can be onerous but, today, not adopting them at all is unwise. The key to success, and good financial reconciliation, is being able to streamline and manage them.
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