Consumer debt stands at £1.3 trillion and the number of personal insolvencies in 2007 has continued to escalate with the trend for Individual Voluntary Arrangements (IVAs) also continuing to grow. All of these factors put a continuing focus on the consumer lending industry as a whole and, with house prices still rising, the question often asked is: what is the industry doing to make sure that they lend responsibly?
The origins of scoring
Scoring was first introduced in the UK in the mid 1970s at the credit application stage. The key drivers for its introduction were to provide speed, efficiency and consistency benefits in the handling of consumer applications for credit and loans. But just as important was the use of scoring to reduce the risk of bad debt.
In the early years scorecards utilised mainly application form data, with only limited data provided by the credit reference agencies. However as sharing of data by the lending industry grew in the late 1980s, scorecard weightings shifted from mainly using application data to a much greater use of credit bureau data. The result was that by the 1990s, scoring methodology – with this wider scope of data – had been so effectively proven that it was considered for use in other areas of the customer lifecycle, including account management and collections.
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But, just as the consumer credit market has not stood still, neither have the services used by the lending industry – and the mortgage sector in particular – to protect its own risk and ensure that responsible lending is achieved. Indeed, the sophistication of credit scoring has moved on by leaps and bounds in the last few years, dealing with all stages of the customer relationship, rather than just the initial application. In particular there has been the development of a number of new forms of credit scoring.
Account management scores
As consumers continue to borrow more, from a larger number of lenders, it has been increasingly important for the mortgage industry to have an understanding of a customer’s total credit commitment. This helps them manage their relationship with the customer. Account management scores help lenders review a customer’s overall financial health. These not only use their own performance data for the customer but other information held by the credit reference agencies.
The same concern about the total commitments of a customer has also led to lenders using indebtedness scores. These help them identify not just good credit risks but whether a consumer might be over-committing themselves by taking out new credit.
Increasing levels of arrears mean collection scores have been considered by lenders in recent times. These are used to help assess and create collection strategies.
However, credit scoring can only do so much to help mortgage lenders manage customer indebtedness. The continued development of data sharing – encompassing wider areas of data and a wider community of sharers – offers the mortgage industry a whole new level of intelligence. Working alongside credit scoring, this is going a long way to stem the rising tide of consumer debt and raise the standard of responsible lending.
Data sharing in the UK evolved in the mid to late 1980s in response to increased shopping around by consumers and increased borrowing. Quite simply it is the principle of credit performance data being shared between contributing members. Credit data sharing is facilitated by the three credit reference agencies. It is a reciprocal arrangement that means data sharers see what other data sharers have contributed on a like for like basis. So, for example, if the data sharer only contributes information about defaulted customers then they are only allowed to see default data supplied by other sharers.
The value of this data sharing philosophy has grown over the last two decades and members now comprise banks, building societies and other loan providers, plus providers of credit cards, telecoms and mail order services. Account information is provided on a monthly basis, relating to the performance of their customers against the terms of the credit agreement. Membership and use of data is governed by the Principles of Reciprocity, which are agreed via the Standing Committee on Reciprocity (SCOR), with membership drawn from trade associations and the credit reference agencies.
The primary principle states that: ‘Data is used only for the prevention of over-commitment, bad debt, fraud and money laundering, and to support debt recovery and debtor tracing, with the aim of promoting responsible lending.’
Currently there are over 380 million credit agreements shared by 290 members on 550 portfolios and the data sharing continues to develop and improve.
A problem shared
There have been a number of initiatives in the last few years that have been designed to help responsible lending and reduce over-indebtedness. The first of these was the agreement by the banks to share all account information on their accounts, including both up-to-date and defaulting customers. Previously a number of lenders had only shared default data on certain portfolios.
The other initiative taken by the banks was for them to share information on current accounts. However, the only financial information that is shared is when the consumer has a debit balance, in other words, an active overdraft with the bank.
Alongside these important initiatives by the banks, the credit card providers have also been moving ahead with a series of crucial developments, designed to protect consumers from becoming over-burdened with credit card debt. For example, in 2005, Barclaycard along with a number of other card providers, instigated an initiative to share more information on the historical behaviour of consumers on credit card accounts. This was in response to concerns of over-indebtedness and specifically over-indebted consumers who only ever made the minimum payment. These consumers were also known to withdraw cash on their card to pay the credit card payment due, creating a vicious circle of debt. This initiative has now been adopted by APACS and the extra data fields are starting to be shared.
On the doorstep
The concept of data sharing is also being adopted for the first time in a different industry sector. Lenders in the home credit market – sometimes referred to as door-step lending – will be soon sharing the data on their clients. This responds to the recent Competition Commission review of the home credit sector. The Office of Fair Trading (OFT) and the Competition Commission believe that the sharing of data by these lenders will enable the consumers who borrow from them to have a better chance of obtaining credit from other types of lenders if they choose to.
The debt purchase market is another sector looking at data sharing positively. This industry has grown significantly over the last few years as lenders look to sell their debtor book rather than retain and collect on them.
Pre-consensual data sharing
Another recent initiative in the data sharing arena is pre consensual data. In simple terms this means information on consumers’ borrowings where no consent was obtained from the consumer when they took out the facility. This would be because the facility was taken out before the consent request was included on application forms.
The Department of Trade and Industry issued a consultation paper on this at the end of last year and is yet to report on the responses received. The main argument for the data sharing was again to help responsible lending and prevent over-indebtedness. If the data was shared there would be an estimated 40million extra accounts supplied.
The future
The amount of data shared could increase substantially with potential new sources coming from the public sector. It is clear that the government has recognised the benefit of data sharing and is keen to see data shared between the private and public sector. Indeed former Home Secretary, John Reid, said earlier this year, ‘the level of data shared within government, let alone between government and the private sector is remarkably low. This needs to change. I believe that we can do this without infringing data protection legislation or people’s rights’.
It should also be noted that as consumers continue to borrow more it is likely that more scoring models will be developed to help predict such things as affordability and the likelihood of a consumer becoming bankrupt or applying for an IVA.
Data sharing has developed substantially over the last 20 years allowing mortgage lenders to gain a better understanding of a consumer’s overall indebtedness, and scoring has allowed the efficient and effective handling of this increased data so that lenders can make the right lending decisions. However as borrowing consumes a larger part of UK consumers’ disposable income, there is a need to ensure that lending decisions are based on more than an individual’s borrowing commitments. Mortgage lenders also need information on the other major commitments that could impact a consumer’s level of disposable income, for example, rent, utility bills, or student loans.
It is crucial, therefore, that the industry and government continue to push for wider data sharing to ensure responsible lending continues.
