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.