If you are involved in matters of finance- in particular, credit disbursement, it is pertinent that you note this revelation- “Good repayment history doesn’t predict good customer”.
Financial institutions (lenders) have built some eligibility criteria elements that forms a basis for their credit decisions. This credit criteria are applied some weights in order of importance. This criterion is not limited to good repayment history, age, gender, repayment instrument, credit bureau checks, Debt-to-Income ratio, rate of turnover, liquidity ratio, amongst others.
Credit decision that surrounds the premise of good repayment history, of course, is considered a well-established tradition in finance. A statistic from a renowned financial institution in Nigeria found that 87 percent of sampled credits in their portfolio were disbursed on the basis of good repayment history of the client. Unfortunately, their analysis does not support the assumption that “applicants with satisfactory repayment history will make a good performance on credit even if other red flags are not put into consideration”
It is pertinent to highlight why it is time for this sacred cow (of over-emphasis on good repayment history) to be made into burgers. Don’t overreact – instead, examine the reasons why good repayment history doesn’t prognosticate performance.
Mode of repayment dictates performance
Past performance is more likely to be an indication of future performance only if the environment doesn’t change. Environment in reference could be the structure of planned repayment. For instance, an initial facility whose repayment plan was based on a “deduction at source” basis (a system that allows for the employer of the client to remit loan repayment to the loan firm) doesn’t exonerate customer’s character. The reason for performance could be validly attributed to the fact that the client had no hold or control of his repayment. As such, it will be foolhardy to conclude on doing business with the same client on the sole basis of good repayment history now that he has control of his repayment.
Exposures determines performance
Although it might seem counterintuitive, good repayment history simply doesn’t accurately predict whether a loan applicant will perform on the next facility in review. This might be owing to the exposure level. It is quite easy to perform on a facility whose repayment has a little impact on a client’s income compared to when the flip side is the case. This explains that it will be myopic to consider the customer’s payment history when the present exposures are evidently on a trajectory increase compared to the past.
Client’s economic metrics
It is a mistake to assume that years of good repayments automatically means character and capability of subsequent request is assured. The economic determinants of an individual are subject to changes notably by Needs and Dependents. One of the questions credit companies ask prospective customers at the first contact is the number of dependents- which are put into the credit decision. Overtime this is subject to increase rather than decrease, same as needs. A look at this is worthwhile as a higher need and number of dependents indicates/ poses a higher risk to loan performance.
Longevity of relationship may contribute to complacency
Although this is more of a qualitative consideration as there is no mathematical or scientific measurement for this. However, it is a phenomenon of human beings. Since the clients are human, it is imperative to give this a thought rather than look this away. Over-familiarisation comes with contempt. Regardless of how long an individual has been loyal in loan repayment, credit risk analyst should always give an allowance of distrust and this should arise from the fact that human beings are adventurous in nature and like to test (most times knowingly) how a loan default would be handled by the lender and their excuse most times arise from the years of loyal relationship.
Macro-economic scenes
Let’s consider the SME as the client this time and not individual. Credit from financial institutions is a major source of income for SMEs and their successes cum failures by a large extent tells on the economy health of country. The loan repayment behaviour for SME customers is heavily dependent on the macro economic variables- inflation rate, rate of unemployment, exchange rate, external debts, trade deficit, budget deficit and the likes. This tells us that the performance of loan is externally determined. As such, a previous good repayment history does not translate to the same happening in the future.
If your organisation is one of the few adopting a 100 percent data-driven approach to credit decision, the latest revelation should guide your orientation and next action during your next review process.
My personal conclusion from this recent research is not that you should completely turn a blind eye to repayment history as a determinant for continuous credit relationship, but you should stop assuming that long time satisfactory repayment history automatically means that the client has more capacity and character to do well. You should be ready and willing to consider other eligibility criteria.
“In a rapidly changing business world, anything that happened more than three years ago may be little more than ancient history”– John Sullivan; Professor, Author, Corporate Speaker of HR-Thought Leader.
