Ten years ago, the UK was in the grip of a major financial and economic crisis that saw huge financial institutions such as Northern Rock and Lehman Brothers collapse. Banks had less to lend and changed their practices. But how did this alter credit decisions, and what did this do to consumers?
Several lenders turned inwards when assessing lending risk, found Brunel marketing expert, Dr Ana Canhoto. She found privileged internal data about customers and lending performance when she looked at how six UK lenders screened customers from 2003 to 2013. This disadvantaged new consumers – or those with few products with a particular lender – when applying for a loan, against others with many products with that same lender.
Lenders removed various products from the market such as unsecured loans or 100% funding. These products are particularly relevant for new borrowers, who have limited savings and/or no assets.
Together, these two factors made it very difficult for certain customers to access credit. For instance, the young, migrants and people who stayed away from mainstream financial services for social or cultural reasons had very limited options. The financial exclusion that resulted would have pushed these customers into high-cost alternatives such as payday loans, credit card debt, and so on – possibly deepening their social exclusion.
But it wasn’t just the ‘traditionally vulnerable’ that would have struggled. Canhoto’s analysis showed that, in the aftermath of the credit crunch, lenders adopted a narrower definition of what constituted a good borrower. Variables previously used as indicators of good credit quality, such as managerial jobs, lost their relevance. Meanwhile, lenders raised the hurdle when applying for a loan. In five out of the six lenders investigated, loan applicants had to obtain higher credit scores to secure a loan than they would before the 2008 crisis. That not only left potential borrowers with fewer choices, but they also faced shifting and more stringent requirements.
Lenders also increased the proportion of loan applications that went through manual screening for approval. This meant lower default rates, which made it a sensible option for lenders to reduce their exposure to bad debt. But manual screening slowed down the reviewing and approving process, meaning it took longer for applicants to obtain a loan. This delay created cash flow problems for some customers, which they dealt with by using high-cost credit such as credit card debt, or payday loans.
The recession put the young, migrants and socially excluded groups at risk of further marginalization, while customers not previously considered vulnerable found themselves in financial difficulties. These groups’ vulnerability resulted from factors completely outside their control. It was the combination of firm-related factors – like reduced risk appetite, fewer products to choose from, tougher requirements and slower screening processes – which, in the end, determined who was and was not deemed a ‘good’ customer.
A sombre reflection, given the cyclical nature of recessions, the long-term consequences of temporary decisions, and the growing evidence that the private sector is neither likely nor able to take responsibility for addressing financial exclusion.
This was first published on Dr Ana Canhoto’s website. The study, co-written with Prof Sally Dibb, is available here.
Image: Basher Eyre / Creative Commons