6 Tips for Debt Collection During the Household Income Squeeze

Households across EMEA continue to wrestle with a combination of rising prices, interest rate shocks and an ongoing squeeze on income. In Britain, analysts predict we're only around midway through an enduring cost-of-living crisis, with average disposable incomes likely to continue to fall. In fact, typical disposable incomes for working-age family households are on track to fall by 3% in this financial year, and by 4% during the year to April 2024, according to the Resolution Foundation.

Only incomes of the very richest are likely to rise, according to the think tank’s annual Living Standards Outlook, while many middle-low-income households are experiencing increasing pressures on finances, with a predicted £2,100 fall in net incomes. This cash flow pressure is resulting in reduced consumption, increased borrowing, and turning to friends and family for financial support. For lower-income households, these coping mechanisms are not enough and real financial stress and hardship is being experienced; families are skipping meals and missing payments on debt, housing and utilities, which is having a detrimental impact on physical and mental well-being.

Source: Resolution Foundation - The Living Standards Outlook 2023

According to the Bank of England, higher mortgage rates — combined with rising costs of living — are now making it far harder for borrowers to afford their mortgage debt repayments. This could cause some households to default on payments or be obliged to cut back sharply on their spending, posing a risk to financial stability. This level of acute household income and cash flow stress has not been seen since the global financial crisis (GFC).

Against this background, it shouldn’t be surprising to many that arrears and defaults are on the rise. The Bank of England reports payment default rates on secured loans to households increased during Q1 this year, and are expected to increase further during 2023. It's a trend also noted by FICO, with our data highlighting the acute rise in payment delinquencies and spend this year. Inflation still remains stubbornly high — although it is slowly coming down — and household income stress is compounded by rapid increases in interest rates, along with relatively high food, fuel and energy inflation.

Customer journeys are set to get more complex. There is likely to be a larger number of vulnerable customers needing debt support and potential forbearance. For UK Tier 1 lenders and debt collectors, it is anticipated that there will be an increased need for digital-led payment plans and a higher demand for loan modification, so the longer-term financial impacts can be worked through. Ultimately, companies will have to manage higher impairments and losses, which will also attract C-level attention to the overall debt collection performance.

Working with our clients across various sectors and geographies, we’ve seen first-hand what best practices in collections looks like. To enhance their debt collection capabilities, organisations have concentrated on three key pillars.

1. Harnessing the power of internal and external data to create a rich, holistic customer view, which can inform your decision making. With the advent of the FCA’s Consumer Duty, there is an added emphasis in the UK on making the data required to create a detailed understanding of the needs, motivations and characteristics of your customers, which can inform not just offers but debt collection as well.
2. The ability to translate this data into actionable insights, underpinned by advanced predictive and prescriptive analytics. These analytics can determine the level of financial hardship experienced by customers and the optimum actions and processes to facilitate a long-term, sustainable solution to debt issues.
3. Sophisticated, bi-directional omnichannel customer engagement facilitating anytime customer auto-resolution.

For many, the three practices have been among the critical tenets of their digital transformation across the enterprise. However, given the ongoing pressures on household finances, these pillars are critical in being able to identify and respond promptly to warning indicators, thereby ensuring appropriate help and debt support is given to customers as and when needed.

Bearing in mind these three pillars, here are our six tips for debt collectors to improve results.

Tip 1 – Use More Data to Spot Warning Signs

The ability to proactively spot and help vulnerable and at-risk customers is critical – and simply cannot be overstated. Collections departments are now tasked with dealing with thousands of customers who are already falling or at very high risk of going into arrears.

As an industry we have always been proactive when it comes to tackling customers encountering debt issues. However, now we need to dig deeper to obtain relevant data and assess the vital information needed to understand individual customer circumstances. The data is there, it is in many cases simply overlooked, and it can be used to inform how we talk to our customers who need to be segregated carefully. There are three broad groups of debt management data.

Internal Data Sources

Significant value resides in the data flowing through your systems, pertaining to your customers financial behaviour, such as:

• Information that tells us how reliant on credit the customer is, card utilization, renewal of UPLs
• Information that tells us about their financial use of financial products — transactor not revolver, direct debit payer, early settlements of UPLs, takes advantage of interest-free offers, low LTV, lower than average balloon payment in terms, number of credit lines
• Changes in card transaction spend type and velocity
• Indicators of credit stress – number of new applications for credit internally and at credit bureau, use of credit for essential expenditure, increasing use or dependence on overdraft facilities or use of short-term, high-cost facilities
• Any information about their industry, occupation, earning potential, stability

External Data Sources

Credit bureau data has long been a valuable data source for debt management purposes. This remains the case and is not expected to change.

This however can now be complemented by gaining permissions for recurring access to open banking data, to earlier identify changes to the customer’s financial position. The most obvious benefits of open banking data are the ability to see employment and disposable income changes in real time, or significant spending events, which are all likely to pre-date a slide into arrears. There are also more subtle changes within open banking data that are likely to become visible even earlier than these events; a reduction in eating out, fewer payments for entertainment subscriptions or shopping at cheaper supermarkets may all be signs of intentional changes made by customers who are starting to struggle.

Customer-Provided Data

Communication is key to ensure an up-to-date view of the customer’s circumstances, and to identify those who are falling into delinquency. Firms should be seeking to capture data relating to the underlying reasons for any hardship experienced, the impact duration, disposable income and affordability. This additional information is vital in helping you understand the consumer’s position now, and where they are likely going to be in the near term and beyond.

By communicating regularly with customers, you can get a clearer understanding of the changing nature of their personal circumstances. Each of these groups of data provides significant value to different aspects of a collections strategy, and so they are best used in combination. The greater the depth of data within each, the deeper the level of understanding and the higher the decision quality that can be achieved.

Tip 2 – Get a Clearer Assessment of Affordability

There isn’t a single generally accepted measure of over-indebtedness or affordability risk, and a combination of criteria and approaches should be applied to evaluate the level of disposable income.

Income and Expenditure Assessments are a critical part of understanding a customer’s circumstances, but the detailed conversations they require are also a significant operational overhead. Firms should consider turning to open banking or collection of data through digital channels, combined with automation of affordability calculations, to identify the right solutions for the growing number of customers in need of support. As well as being more scalable, it's also well understood that a digital-first approach provides more convenience and avoids embarrassing conversations for customers, which results in higher levels of customer engagement.

It's important to consider how comprehensive a view of a customer’s finances is being enabled by the data collection processes that are in place. For example, it’s too easy to neglect the increasing impact to disposable incomes from the continued growth in consumer use of BNPL payment options. Ensuring you capture these ‘out of sight’ future financial commitments will prevent blind spots that increase the risk of unsuitable treatments.

Credit bureau data and other behavioural indicators also help signpost trouble and can play a key role in supporting the use of forward-looking analytics to detect the effect of incremental debt and higher repayments on default risk.

Tip 3 - Engage Customers through the Right Channels

The most effective engagement strategies are those that are led by the customer. And the ideal is one that provides the flexibility and convenience to allow customers to engage at their preferred time and channel, and offers clear, simple mechanisms through which they can disclose any relevant information and can gain access to the information and guidance to help them make informed decisions on the best course of action.

Given this, true omnichannel communications are critical — engaging the customer through the right channel at the right time and recognising that multiple contacts might be necessary to be able to agree an appropriate solution. Does your existing technology enable customers to auto-resolve on omnichannel platforms across a range of channels including auto voice, iSMS/WhatsApp, digital direct API, email, mobile app, online or through edocs? Can you change your contact strategies quickly enough to keep pace with the rapidly changing environment to ensure customer engagement is maximised and sustainable solutions are rapidly found to help customers through their financial issues?

Tip 4 – Review, Review, Review…Then Change Where Necessary

A key to success is to keep reviewing all aspects of debt management; stay close to changes in your customer profiles, track the efficacy of your policies and treatment paths, the contents and efficacy of your Collections toolkit and the alignment of your operations. If sub-optimal outcomes are noted, make sure you have the systems that allow you to adapt quickly. 

Your customers’ financial circumstances are continually evolving. Right now, many more are experiencing financial pressure and your collections treatments need to support them as individuals. As the stresses on household incomes recede or increase further, the treatments you use to provide the right, sustainable outcomes to customers need to evolve too. In the UK, the ongoing review of customer outcomes is mandated by Consumer Duty; this is a point where commercial and regulatory requirements are aligned.

Many customers are going to be looking to lenders for support in the form of forbearance or restructuring. The options you have within your toolkit should be continually reviewed against the evolving debtor profile of your customers, and the same applies to the efficacy of the restructures you agree with customers. Regardless of whether it is a short- or long-term restructure, only long-term sustainability can be considered a good customer outcome. The identification of which solutions will provide the best outcomes is something that can and should be considered for decision automation and optimization.

Tip 5 - Make Better Change Decisions More Quickly

Over recent years we have gone through an immense amount of change, and the current macro-economic environment is volatile and uncertain. Historic performance can no longer be a reliable indicator of the future. Being able to quickly perform simulations and scenario testing is vital in providing a view of the ‘what if’s’ and the trade-offs inherent in designing and applying customer treatment strategies. Having the ability to rapidly understand the potential impact and implications of change, whether internal or external, is vital to enabling businesses make informed decisions on how to treat customers and how to best leverage finite resources.

As examples:

• What are the implications of maintaining or reducing staffing levels given increasing volume of customers entering hardship?
• What are the potential impacts of proposed regulatory changes?
• What is the likely impact on key business metrics of further deteriorations in the macro-economic environment?

Having the capability to answer these questions quickly and accurately is a key differentiator for businesses enabling more informed stakeholder discussions and decision making, and acting as an accelerator for change. 

Use of decision optimization techniques in collections can be applied across the different stages of the credit and risk lifecycle to solve different problems at each stage by defining the decisions that need to be made. Optimization helps evaluate and discover successful decision strategies, which will meet sometimes conflicting business objectives whilst accounting for any constraints. Decision optimization has applications across the collections lifecycle, from pinpointing the engagement approach and appropriate debt solutions for financially vulnerable customers, to focusing resources and applying appropriate treatments to maximise the proportion of customers returning to order in early collections, to enabling cost-effective management of non-performing loans.

Simulation and optimization can be a game-changing practice, enabling significant improvement in business results whilst enabling better customer outcomes. It is strongly recommended that banks and institutions review their existing capabilities in these areas and strengthen where required.

Tip 6 – Ensure Operational Alignment

The effective execution of any collections or recovery strategy depends on having the right people, in the right places, enacting the right procedures, using IT infrastructure that provides the required data, communication, review and change capabilities. Make this your target state.

Misalignment or poor execution in any of these areas will introduce some degree of operational negation, which will impede your successes. Given the cost of bad debt on the balance sheet, it is surprising how easy it can be for drift to set in, causing divergence from your target state.

Automated decision and communication systems, which provide flexibility and transparency by making all the constituent data available, are vital in providing the controls that prevent this drift setting in. Exceptions from these automated decisions will always be necessary to provide treatments can be truly personalized, and so long as they are transparent, provision should always be made for these.

How FICO Helps You Improve Debt Collection

• Explore our solutions for debt collection and recovery
• See our solution for customer communications with borrowers
• Watch the webinar with FICO and McKinsey on digital-first collections