Post-pandemic credit risk management
Managing credit risk traditionally is deeply tied to knowing who the applicant is, the details of its business and how it has fared, economically, in its most recent months of operations. Most of credit institutions require reviewing between 3 and 12 months of historical data before taking a credit decision. All of this has been turned upside down for a very simple reason: historic data is no longer relevant for the assessment of credit worthiness. And if we are operating under the assumption that we will one day go back to a state of normality, historic data is no longer useful to try to understand which balance sheet our regular bits of economic activity will help. There has already been an large amount of seminars and blog posts about how the pandemic has catapulted most of larger institutions into a working from home frenzy, where IT departments have been working around the clock to make sure that employees and employers can feel safe. But not much has yet been said about second-order effects that are to be expected from the pandemic. One of these effects are what impact the pandemic has on credit worthiness assessments. New approach In order to make up for the missing historic data points, traditional lenders will need to pivot into data sources that are either real-time or forward-looking. Further, they would also need to develop new ways of assessing sector impact using either pooled corporate treasury data, aggregated bank account data, or alternative data sources that would provide an overview of which sectors are hardest hit by the pandemic. But just reviewing sectors will not indicate credit worthiness of an individual company, which is where transaction data is extremely important – a topic which is becoming more and more relevant with the introduction of open finance. Other data points, such as online reviews, ratings and reservations are also very useful in this context. Sector-specific solutions At Yoba, we believe that deeply understanding a sector before lending is crucial not only for understanding what the associated credit risk is, but also to develop tailored sector-specific solutions. A crude example would be identifying sectors that are having issues around a specific time of year, analysing possible sector-specific solutions and offering these proactively to companies. Doing so will be a win-win situation for all parties involved. This graphic, put together by McKinsey, provides a good overview of the challenges and possible new approaches that can prove useful in credit worthiness assessments going forward:
Conclusion Pondering the second-order effects of the pandemic is an interesting and very ambiguous topic. It is clear that the pandemic has not only created a necessity for innovation in the way we work but also changed credit risk management. In order for lenders to remain relevant, it is important to continuously evolve together with its borrowers, and that lenders keep innovating on which data points that most accurately depict the situation of a company.
We recommend digging into this excellent McKinsey report if you are interested in reading more about this topic.