Banking Analytics Blog

Even in a Recession, UK Cardholders Paying on Time

2012-05-25T01:48:57-07:00

Even as figures show the UK stretching out its recession, cardholders have clearly learned the importance of keeping their card payments timely. Today FICO released data on Q1 card payments that show one-cycle delinquent balances, as a percentage of all balances, falling to less than 5 percent, the lowest point in two years. Also down were the percentages of accounts that are 30 days delinquent and that are overlimit.

While there are also seasonal effects in the data, this appears to be a sustained reduction in delinquent payments. Clearly, cards are at the top of the “payment hierarchy” for UK borrowers.

Should We Trust Your RWA Models?

2012-05-24T05:32:10-07:00

According to today’s Financial Times, 63% of investors have lost faith in bank’s internal models to measure their risk-weighted assets (RWA). In an article titled “Investors lose faith in banks’ RWA models,” the paper says that many investors surveyed recently by Barclays would like to see big banks use the “standardized” method of measuring RWAs for Basel, rather than their own models as allowed under the internal ratings based (IRB) approach.

The Basel Committee established the IRB so that banks could use their knowledge and experience to move away from the Basel I “one size fits all” approach. Many have invested in large modelling teams that develop models that are more accurate for their own portfolios. Sceptics feel banks may be “fudging” those models to reduce their reserve requirements — in other words, making them less accurate, not more.

FICO’s not a regulator, and we wouldn’t presume to comment on what regulators or institutional investors feel may be happening with internal bank models. But we do feel the IRB is worth preserving.

The wisest banks use their RWA models not just to calculate capital requirements but to make day-to-day lending decisions. These banks have every incentive to make these models as robust and accurate as possible. If critics doubt the integrity of these models, more scrutiny should be given to the methodology used, the changes that result in adjustments to key metrics like loss given default, and the validation process. This isn’t rocket science — it’s what regulators worldwide do to ensure the safety and soundness of lending practices.

FICO has worked with many clients in EMEA and elsewhere on Basel model development and validation. We have helped lenders adopt economic impact models that offer a better way to project the effects of different economic cycles on credit risk in a consistent and explicit way. I have personally worked with clients to make their RWA calculations stronger, which may indeed reduce capital requirements, but only because the standardized approach — being less precise — overestimates the risk for many portfolios. If this frees up more capital, it will also help lenders meet that other demand of regulators — putting more credit into the local economy.

Internal models should be more precise, and doubts about their validity should be laid to rest with facts, not the elimination of a good practice. We stand by the intent of the IRB.

The skinny on FICO® Scores and inquiries

2012-05-21T10:03:27-07:00

One of the largest misconceptions around how the FICO® Score works involves its treatment of credit inquiries, and what happens to a score when a consumer applies for credit. In this post, I’ll answer some of the most common questions we receive on this subject, from lenders and consumers alike.

Does the FICO® Score penalize for rate shopping?
FICO® scoring models use specialized logic that accounts for rate shopping for student, auto and mortgage loans. In general, student loan, auto and mortgage-related inquiries that occur 30 days prior to scoring have no effect at all on the FICO Score. Outside this 30-day period, student loan, auto and mortgage-related inquiries that occur within any 45-day period are treated as a single inquiry.

This inquiry logic applies to loans of the same type. In other words, if someone were shopping for a car loan and home loan during the same 45-day period time period, the auto loan inquiries would be counted as one inquiry, and the mortgage loan inquiries would be counted separately as another inquiry. This is because they represent two separate searches for credit. (Remember that all auto, mortgage, and student loan inquiries made within the last 30 days would not be counted at all.)

The best advice for consumers concerned about score impact is simply to do their rate shopping in a reasonably short period. That's easier if borrowers do their homework ahead of time to decide which companies to approach for quotes. Such planning also should make the loan rates easier to compare since the quotes will come only a few days apart.

Do all inquiries affect the score?
No, the only inquiries that count toward a FICO® Score are those that result from when a consumer actively applies for new credit. The FICO Score does NOT consider:

Consumer disclosure inquiries — requests made by consumers to obtain a copy of their individual credit report in order to check it.
Promotional inquiries — requests made by lenders in order to make pre-approved credit offers.
Account review inquiries — requests made by lenders to review existing accounts with them.
Employment inquiries — requests marked as coming from employers.
Insurance inquiries — requests marked as coming from insurance companies.

How much does a credit inquiry impact a FICO® Score?
In general, inquiries have a small impact; typically, a single inquiry can lower a FICO® Score by less than five points. (For more facts on inquiry impact, check out my last post.) The precise impact will vary based on each person’s unique credit history. Inquiries can have a greater impact if consumers have few accounts or a short credit history.

Among the five data categories that make up the FICO® Score, inquiry characteristics fall into the “search for new credit” category, which accounts for only 10% of the score. Since inquiries only represent one type of characteristic in this category, they actually account for less than 10% of the score.

Why does a credit inquiry affect the score?
Research consistently demonstrates that consumers who are seeking new credit accounts are riskier than consumers who are not seeking credit. Statistically, people with six or more inquiries on their credit reports can be up to eight times more likely to declare bankruptcy than people with no inquiries on their reports. While inquiries often can play a part in assessing risk, they play a minor part. Much more important factors for the score are how timely a consumer pays bills and his/her overall debt burden as indicated on the credit report.

For more information and advice to consumers, you can direct your customers to check out the credit inquiries page on myfico.com.

Data asset or data liability?

2012-05-16T00:58:56-07:00

One distinguishing factor of successful businesses is how well they capture, maintain, access and interpret data. Why is it, then, that many businesses fail to adequately protect their data assets, and even more fail to provide for sufficient contingency should data become lost, damaged, corrupt or compromised? Data compromise remains one of the most prevalent challenges, and the one most feared by consumers.

The banking industry has been heavily regulated in terms of data management and, indeed, many banks have even set about trying to render certain data worthless if compromised. They’re relying less on static information and more on variable data that can only be derived, not read "in the clear." Multi-factor authentication, for example, is increasingly becoming the standard for accessing and changing personal and financial records, especially across remote channels such as the internet and telephony.

But there is still much to be done, as discussed at the recent FICO-hosted business continuity event, where over 30 professionals across a variety of industries explored the challenges that their businesses might face in this London Olympics year. The UK tripartite of HM Treasury, the Bank of England and the Financial Services Authority had set the tone in their Market Wide Exercise last year, where banks had to show how they would respond to a large-scale cyber threat impacting payment, account and customer record integrity. The results showed that most banks were unaware of how pervasive such an attack might be, and were unprepared for the full consequences.

There is no such thing as perfect data security and there has to be a balance drawn between practicality and exposure risk, between convenience and cost. But all banks should be focused on determining the relative value of data assets, adopting increased security in all data handling protocols, increasing resilience through secure replication and storage, and creating failsafe procedures in the event of real or threatened compromise.

Customer centricity and the halo effect

2012-05-14T16:00:00-07:00

Many FICO clients are seeing benefits from customer-level decisioning. But some of the impacts are a bit tricky to quantify. One of these is the so-called “halo effect.”

It’s intuitive that customers who have a good experience with one type of account are likely to be more receptive to offers to extend the relationship into other types of accounts. “My bank is doing a good job with A, so they'll probably do a good job with B.” When this broader relationship is established and nurtured, customers tend to behave more profitably across all their accounts than customers with only a single account.

The halo effect also works in reverse. Customers angry at being charged fees on their debit accounts, for example, may transfer a negative view of the bank's performance to other existing or potential future account relationships. Even if a customer closes just one account and looks for an alternative provider, the opportunity is now there for that competitor to develop a halo effect of its own. They might do such a good job that the customer begins to look to them for other financial needs.

Preventing this kind of erosion in customer relationships is a key reason many banks today are working to improve management of and expand transactions in their current accounts / demand deposit accounts. The more advanced the use of these accounts for inter-account transfers, as well as for automatic payments, point-of-sale purchases and other transactions, the more challenging it becomes for customers to migrate to another financial provider. Strong performance in this area, therefore, creates "sticky" relationships that yield longer-term loyalty and encourage cross-sales.

Is There Really Safety In Numbers?

2012-05-10T08:58:45-07:00

In a week where FICO has published its interactive fraud map showing how European card fraud has changed over the last 5 years, and reflected on the considerable reductions across the UK card fraud market, there was a cautionary tale issued by the mass media. The Guardian has published an article about how UK banks are getting tougher on card fraud consumer victims: “Now banks are trying to pin the blame for card fraud on you.”

As I reflected upon in this blog almost 2 years ago, there remains an “ambient” level of fraud caused by fraud migration and mutation. Banks are now often grappling with an increasing frequency of identity theft, first-party fraud and “friendly fraud” (the latter where credentials are shared maliciously). Trying to distinguish these types of fraud attacks from the otherwise innocent consumer victim is often incredibly difficult.

Is it any wonder, therefore, that the banks and even the Ombudsman may increasingly conclude that card and PIN use denied by a consumer must have its origins in either neglect of the payment token, such as sharing a card, or disclosure of the verification credentials, such as writing down or disclosing one’s PIN? Otherwise how else could the fraud occur? Unfortunately, there are times when an innocent consumer may find themselves subject to apparent neglect/disclosure fraud.

This serves as a strong reminder for consumers to be vigilant and to treat their cards and personal access details “like cash.” Anything less may lead to an unwelcome conclusion by one’s bank in the event of unauthorised use.

This cautionary tale is also an excellent example of why banks must continue to adopt and maintain anti-fraud defences in spite of chip and PIN successes. Anomalous or irregular access, spending or withdrawals can be spotted and distinguished from genuine consumer activity, and verification contact made to the consumer, before a fraudster has the chance to perform runaway spending or plunder available credits.

How European card fraud has changed

2012-05-09T09:13:22-07:00

American philosopher George Santayana is credited with saying that those who don’t remember the past are condemned to repeat it. Today, FICO released an interactive fraud map showing how card fraud has changed over the last 5 years across Europe. While many of these trends have been previously observed, comparing the countries and noting cross-Europe trends gives a different perspective on what we’ve been through over the past few years. This gives us all a chance to remember the past and thereby avoid future repetition.

It’s been pretty widely reported that UK card fraud has dropped over the last decade, mainly thanks to EMV chip and PIN standards, and to use of advanced anti-fraud systems. What the map makes clear is that this fraud hasn’t disappeared — it’s simply migrated to other countries, typically those who were slower to adopt or leverage EMV standards, or those who neglected to keep up-to-date with their fraud defences. France and Germany are particularly pertinent examples of not forgetting one’s history.

Domestically France was the first country to adopt chip acceptance standards (not EMV, but an earlier version known as B0’) in the 1990s in order to provide a robust defence to card fraud. Unfortunately, the knowledge gained about the value of fraud defence investment did not carry through to the modern day. France’s slower adoption of EMV standards and the compromise of B0’ caused fraud to mutate and grow across the French market.

Similarly Germany, with a predominately debit rather than credit card portfolio, had not seen the sort of legacy card losses typically associated with credit cards, and therefore had not invested in the anti-fraud systems and technology that other EMV countries had embraced. Consequently, as EMV adoption began to make card fraud difficult to perform in other European markets, fraudsters migrated to the “weakest link.” This represented those without EMV, or those (like Germany) with otherwise more basic anti-fraud systems.

As the data supplied by Euromonitor shows, the UK’s piece of the fraud pie has shrunk dramatically since 2006, but France is up and Germany’s fraud has doubled, from €63 million in 2006 to €142 million in 2011.

I encourage you to play around with the map for both country-level data and cross-Europe insights, and to derive your own conclusions alongside what we’ve highlighted—provided thanks to thoughtful analysis by my colleague Martin Warwick.

Regulations still choking European credit

2012-05-08T01:48:54-07:00

“Asphyxiating” is a strong word, but that’s the word used at a recent meeting of banking leaders in Spain to describe the effect Basel regulations are having on credit. The meeting, hosted by FICO and the publication Expansion, demonstrated bankers’ frustration and showed that regulators are still searching for the balance between risk avoidance and credit growth. Until this equilibrium is found, banks will struggle to supply credit, and international banks will have to deal with a bewildering variety of demands from different regulatory bodies.

The uncertainty of the situation makes bank agility critical. Unfortunately, agility is not the reality for many of them.

Bank’s regulatory managers and risk managers are now being forced to talk to each other at least to evaluate business impacts over new laws. This momentum is positive, as it will help fashion the new Risk Manager: stronger, better informed and able to cope with regulators while keeping or even increasing profitability. But time is short, bank profitability is low, and banks need to act now to fix their capital problems and their credit supply problems at the same time.

Putting the customer at the center of every decision

2012-05-06T16:00:00-07:00

My fellow blogger Rita Chakravarti recently noted that customer centricity has become a central theme in her conversations with banking professionals. I’ll add that most financial institutions are tackling this in stages. We’re seeing them move toward full customer-level management capabilities gradually, and reap profit gains at each stage for each product line.

Here’s an example. I’ve been working with an Australian bank committed to putting the customer “at the center of every decision.” The bank began by implementing a policy that required all account-level strategies to be evaluated with customer-level data and scores, even if only as a knockout rule.

The bank then advanced to customer-level scoring. Traditionally it had calculated account-level risk scores in isolation then rolled them into a cumulative customer-level score. But this resulted in sub-optimal identification of risk, as influencing product relationships (cards, deposit accounts, insurance, investment/pension holdings) were not being taken into account. Also, multiple good/bad definitions created complexity and structural weaknesses in decision processes.

By integrating its models and scorecards, the bank is now able to generate a streamlined customer risk score, which it is incorporating, along with other customer-level analytics and data, into action-oriented segmentation aimed at expanding customer relationships.

For the time being, the bank is creating decision strategies that match offers and other treatments to customer segments at the account level. A credit card line increase strategy, for example, was optimized to maximize both offer response and profitable utilization. The ability to run multiple scenarios by varying constraints also helped the bank adapt to the country's changing regulatory environment.

The holy grail, of course, is for banks to use customer-level data in customer-level analytics for decisions implemented at the customer level. Most aren't there yet—but it’s on the horizon.

Gaining Speed to Market with Best Practice Collections

2012-05-03T17:56:19-07:00

These days, collection managers face many tough questions. How can we do more with the same resources? How can we make sure to work the right delinquent customers? Can we improve the timing of collection actions? How can we improve kept promise rates and offer better customer service? And, how can we make improvements in weeks rather than months or years?

Collection managers are looking for speed to market with their initiatives, and a quick ROI so that everyone, from senior management to collectors, can see results. In today’s environment, budget for investing in new collections technology is scarce, the availability of in-house IT resource is often more scarce, and projects are prioritized strictly on ROI impact. Yet it's still possible to make a significant impact in collections performance and improve customer service without huge investment.

This is the focus of my upcoming FICO webinar, Gaining Speed to Market with Best Practice Collections, to be held on May 10th. Together with my colleague Steven Matthews, who is a FICO global business consultant, we’ll look at ways of implementing proven initiatives, many of which build on existing legacy technology, in a matter of weeks rather than the longer timescales typical of significant improvements. If this interests you, it would be great to have you join us.