Rebooting risk management for scale under open account finance

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Bakhtier Pulatov, Head of Product at Trade Ledger™ talks about the impact of data-driven lending on risk management and business models and shows how better data and information flows automate remote risk processes and catalyse positive outcomes.

There’s a strong undercurrent pulling lenders into the future and it has to do with open account finance. In this new era, data-driven lending is not just changing workflows but also entire business models.

The impact is especially visible in risk management that is evolving from a fixed to a growth mindset. Forward-looking lenders are changing their static model of customer intelligence. They are adopting a model that evolves based on constant information flows and uninterrupted risk assessments.

Part of the change is born of necessity. The lockdown made it clear that the current setup does not work - neither for SMEs, nor for lenders. Paper-based origination, labour-intensive manual processes, and siloed customer information have crippled capital providers. Neither party can afford to continue the same way.  

But, there is also a massive innovation opportunity - to lower friction, cost and decisioning as well as deliver lending services much better suited to companies’ needs.

The three urgent problems lenders must fix:

1. Inefficient resource allocation

During lockdown, lenders that had underinvested in digital loan monitoring and auditing capabilities became unable to handle the deluge of loan applications.  

That’s because credit managers:

  • Work with fragmented data sources to collect and aggregate information on prospective borrowers. As an additional risk, this data is sometimes low-quality.
  • Manually gather and merge this data, a time-consuming, outdated process that is prone to error.
  • Rely on scoring models that don’t account for intangible assets, an increasing frequent occurrence in SME. Consequently, they often turn down prospective borrowers who can’t use them as collateral - and lack any other tangible assets to utilize.
  • Source: Moody's Analytics

    To this day, the majority of offerings from lenders revolve around fixed terms. These rigid conditions involve a comprehensive assessment. (Acquiring the data for this evaluation is always a high-friction process for the customer.) And what is more, if the same borrower needs a new loan at a later time, they have to restart the process. This is especially true of SMEs, whose dynamic and situation change at greater speeds.

    2. Imperfect, fragmented auditing processes 

    A recent internal analysis showed lenders spend up to 45% of their valuable time on loan monitoring and audits. During the pandemic, this rose further. Quickly deteriorating portfolio quality forced them to spend more than 80% of their time on loan monitoring and audits in the first half of 2020.

    The root cause is data and manual processing. Without unified data streams that feed the decision-making process with high-quality information - consistently -, credit managers spend their time on tedious work. It’s difficult for them to serve potential customers and they often fall short of their existing customer’s expectations.

    Source: Moody's Analytics

    While adding more credit managers and portfolio monitoring officers to the team may seem like the right solution, this is the type of problem hiring more people will not solve.

    3. Low-priority, limited monitoring capabilities

    Lenders invest a lot of resources in the initial underwriting but put limited effort into credit monitoring. They lack the analytics to successfully carry both themselves and their customers through the lifecycle of the loan.

    What’s more, loan monitoring workload increases exponentially when the loan portfolio is not doing well. It’s a well-known problem that mushroomed during the lockdown. 

    To ensure the borrower is financially sound during periods of financial turbulence or crisis, credit managers have to monitor and revalue collateral, update internal risk limits, assess the prospect of covenant breaches, and communicate with financially distressed borrowers. In this context, they are forced to sacrifice speed for accuracy.

    Rebooting business lending with automated risk management

    Legacy business finance is defined by a fixed range of products with rigid terms and a strong focus on initial underwriting. Unfortunately, this leaves many lenders just waiting for the financial contract to expire, unable to capture other opportunities that emerge along the way.

    Under open account finance, credit providers supply a very flexible set of financial products with highly adjustable time periods. They also have the ability to constantly monitor the borrowers throughout their lifecycle.

    Borrowers and lenders do not have to start from scratch every time they need to access and dispense capital. The technology is here to streamline applications and automate the better part of lending decisions. It’s time to break this debilitating cycle and boost profitability while shortening the time-to-cash for customers.

    Fast, customized underwriting with open account finance

    Data-driven lending makes this possible. It taps into various streams of real-time information and consolidates them into a single source of truth which enables them to produce a vast range of outcomes. That’s the kind of integration and efficiency the end-to-end lending orchestration platform can provide.

    Data acquisition evolves from a moment-in-time snapshot to a constant process that runs in the background. This makes it much easier to monitor internal limits against the values specified in their risk appetite, policies, and procedures. The moment the system spots a deviation, credit managers get an alert which helps them act proactively.

    Automating manual activities benefits everyone. On one hand, sourcing customer data from accounting packages removes friction for both parties. It enables lenders to fully automate monitoring of all covenants which are based on financial ratios calculated from the borrower’s balance sheet, income statement, and cash flow characteristics.

    On the other hand, auto-updating borrower data significantly increases the quality of the underwriting itself. Plus, it frees credit managers so they can focus on more complex applications, driving more value through their work.

    While some information, such as key management changes or acquisitions, will always be monitored manually, there is a vast opportunity to simplify and standardise data collection to remove bottlenecks, lower time/cost-to-serve, and increase both client and staff satisfaction.

    Achieving operational efficiency

    To build an efficient loan monitoring and auditing process, lenders must ensure the workload is calibrated to the purpose. More specifically, monitoring frequency and depth should suit the type and risk profile of the borrower and the type, size, and complexity of the credit facility.

    Open account finance makes it easy to monitor early warning signs of declining credit quality. It enables lenders to carry out more frequent and in-depth reviews if the platform identifies a deterioration in the borrower’s credit and asset quality. Monitoring can also be adjusted based on risk profile and deal size to discern between smaller deals that require less frequent examination and bigger, riskier deals that require more senior expertise and resources. 

    At the same time, lenders can continue to monitor borrowers in good financial standing as a background process and free up valuable analytical resources to tackle these complex cases.

    Remote auditing that scales growth

    Post-pandemic lending has to be data-driven lending, as facetime between borrowers and credit providers will decrease substantially. We saw this when the lockdown made it impossible to meet in branch offices, a situation that may reappear in the not-so-distant future.

    For a lender looking to scale, physical auditing is not an option. However, getting to know their customer thoroughly and maintaining that knowledge over time is.

    Once acquired, the borrower continues to be a customer as long as the lender continues to serve them well. In this way, lenders do not have that constant cost of customer acquisition and the borrower does not have to keep shouldering the cost of shopping around for the best offers. That makes open account finance quite similar to the concept of software-as-a-service.

    SMEs need open account finance to survive

    The future of SMEs - and the millions of jobs they create (70% of employment, according to the OECD) - also relies on making applying for credit faster, more effective, and more flexible.

    Because traditional financial institutions have been slow to digitize their process and integrate new technology, non-bank financial institutions emerged to capture the opportunity.

    “[...] banks face an increasingly dynamic competitive landscape, including the entrance of deep-pocketed alternative nonbank lenders that are using technology to find borrowers and underwrite loans, often using unconventional lending practices.”

    To remain competitive and to protect their net interest margin, especially under turbulent conditions, lenders must become leaner by adopting technology that streamlines applications and automates the better part of lending decisions. 

    That’s what makes open account finance so important. This new, innovative product introduces a lot of flexibility into financial products.

    Rather than being confined to a fixed amount for a fixed period of time, it creates an opportunity to change the limits or to work with a customer on changing the borrowed amount based on how the financial situation of the borrower evolves over time; effectively becoming a recurring lending facility that evolves according to needs with no renegotiation required

    Furthermore, armed with deep knowledge of their customer, lenders can also become very competitive in terms of pricing. Other credit providers unfamiliar with open account finance will charge a premium because, for them, the customer is an unknown entity.

    This change is also beneficial for the SMEs because open account finance products are nowadays offered at very competitive interest rates. Moreover, it saves them the effort of decoding and comparing complex offerings because lenders can provide better guidance as they know them much better.

    Reasons to be optimistic, reasons to invest

    As we have written about before, the silver lining of the pandemic is that it underlined the need to invest in new scalable lending infrastructure. This new technology coupled with the information flows unleashed through open finance will usher a series of benefits for lenders and borrowers alike. Faster decisions. Scalable auditing. Lower costs. Less friction. But most importantly, money will flow to SMEs, in an ongoing fashion with terms tailored to their context and needs, and that will boost economic growth and opportunity for all.