We’re nice people in the credit union movement. We often ‘err’ on the side of accepting loans, especially where borrowing will really help members out of a tricky situation. This can knock our risk appetite out of line with expectations.
In such circumstances bad debt costs run over budget. Members may want (and intend) to pay but times are hard. The cost of living is rising faster than incomes. Welfare benefits are being cut. One in five people have their universal credit payments delayed. Housing Benefit no longer covers the rent.
Aligning your risk appetite with a credit score
Setting a credit score cut off point for accept, referred or declined loans is a good way of budgeting for bad debt. But there’s plenty of flexibility. It doesn’t have to be a blunt instrument with no sense of economic justice.
Setting a wide refer range for higher risk loans is a way to avoid turning away existing members with poorer credit scores.
A working example
Imagine three loan products, typical values and target bad rates. A credit score (in this case out of 500) provides a target bad rate.
|Product||Typical value||Write off budget||Refer score||Accept score|
|Starter loan||£500||6%||370 – 419||420|
|Saver loan||£1,500||4%||420 – 449||450|
|Home owner loan||£5,000||2%||450 – 474||475|
Whilst there are no guarantees, as the unexpected can happen, the accept score delivers the write off rate you desire. In this example the refer ranges add another 2% to the bad rate for Saver and Home owner loans (although this can be configured).
In the example above, the bad rate for referred starter loans has been set so it goes all the way to 10%. There’s plenty of scope to ensure that its never ‘computer says no’.
You may also find our post about using credit scoring to manage a wider loan portfolio useful.
NestEgg’s Decision Engine is an easy way to automate such an approach.
Its best practice for a credit union to have a risk appetite statement. Risk appetite expresses the maximum level of risk that a credit union is prepared to accept to achieve its vision and business objectives.
A best practice appetite statement typically details overall level of risk the credit union is prepared to accept. Other sections often cover specifics around lending, regulatory, reputation and financial risk.