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Alloy's credit risk management best practices to navigate financial volatility

Managing Credit Risk 1

In the financial world, the domino effect reigns supreme. Every entity—from individual customers to banks and fintechs—feels the impact of market fluctuations.

Today, for instance, small and mid-sized businesses are grappling with rising costs. And with mortgage rates the highest they’ve been in 21 years, consumers aren’t doing so well either. As for lenders? During periods of financial instability, they often tighten their credit policies to minimize financial risk.

In this environment, demand for many credit products remains high. Credit card debt, for example, has reached a new high, and demand for commercial loans among micro, small, and medium-sized businesses grew 33% year over year in the first quarter of 2023. This poses a critical question for lenders: Is an extremely conservative approach the best credit risk management practice in a volatile market, or can it be counterproductive?

In an ideal world, customers have the cash flow they need to thrive even in tough times. Meanwhile, for lenders, the sweet spot lies in keeping the balance between opportunity and risk. Although it seems like a catch-22, there is a middle ground.

This is where Alloy Credit Underwriting comes in. When economic conditions are unpredictable, decisions must be made quickly and carefully, and traditional credit underwriting workflows that rely on slow legacy systems just don't cut it.

Alloy takes a different approach. By automating workflows, combining data sources, and expanding lenders’ visibility, Alloy simplifies and improves the credit decisioning process. With access to diverse data sources, lenders use Alloy to get a holistic picture of applicants, making it easy to adapt their credit models as the market shifts.

That's not all. Alloy also allows lenders to review applications throughout the entire customer journey, making it easier to spot when a potential customer applies for multiple products or sort applications by stage. So, viewing an applicant's journey from start to finish is effortless, and banks and fintechs have insight into their entire life cycle.

The result? Underwriters can effectively manage risk and still seize opportunities through the economy's ups and downs.

Let's dive into how underwriters can navigate financial volatility with Alloy's three credit risk management best practices.

1. Balance customer experience and credit risk management

When there's financial uncertainty, many banks and fintechs are highly averse to rocking the boat, as evidenced by the significant drop in loan approvals in the last three years. But here's the problem: businesses and consumers need cash flow to survive and eventually boost the economy.

Many small businesses have only enough savings to last two months if sales drop, and 17% don't have access to funding at all. So, a sudden loss in customers (which is not uncommon during periods of high inflation) could force them to close. With interest rates hovering between 9% and 12% for the average business, these companies are already cutting back on their investments, inventory purchases, and hiring — meaning, they're doing everything they can to stay afloat.

Customer loyalty will pay off

As bleak as that may sound, there’s a better way to look at the situation. Challenging economic conditions offer banks and fintechs a significant opportunity to foster customer loyalty. And loyal customers help boost a bank or fintech’s revenue.

A 2019 study shows that loyal customers often own more products from their primary bank than less satisfied customers. Additionally, happy customers are two to six times more likely to recommend their bank to others and are less inclined to switch to a different bank.

But, the solution isn't to overlook a borrower’s creditworthiness for customer experience. Instead, underwriters should gather as much information as possible to closely understand the customer’s financial behavior.

With a more holistic view of customers' behavior, lenders are able to identify and recommend the right credit products at the right time, winning their loyalty in the process. Most importantly, lenders can do it without compromising on compliance or risk assessment.

With Alloy, getting these insights becomes much easier.

How Alloy does it

Alloy allows banks and fintechs to harness historical customer information, ingest information from the financial institutions' internal systems, and pull in fresh data from third-party data sources to support their decision-making. In turn, lenders can make informed decisions by examining a broad range of credit signals.

Alloy offers automated, scheduled checks to monitor borrowers and intelligently route them through the best decisioning path based on their actions and behavior. For example, a lender could set up a weekly refresh for any customers who meet the following criteria:

  • A minimum credit score of 650

  • A minimum account balance of $10,000

  • No history of missed payments

If a customer meets these requirements, they can be shortlisted and routed through a separate decisioning path to approve them for a higher credit limit or an additional credit product, like an auto loan or a travel rewards credit card. Since the lender has access to a comprehensive customer profile, they can extend pre-approved offers or provide more relevant credit offerings to the customer. Plus, banks and fintechs reduce operational costs and make more data-driven decisions.

Learn how Alloy Journeys allows you to link multiple workflows into a single configuration.

“Alloy makes it very easy to pull an evaluation and understand if an applicant was approved or declined — and why,” said Jetty’s Senior Product Manager, Gal Katz.

Take it from Jetty, a fintech on the mission to make renting more accessible and affordable for consumers. Alloy automated the onboarding and credit underwriting processes for Jetty. As a result, Jetty not only decreased application review time to under 10 minutes, but could also offer pre-qualification decisions to applicants within seconds.

Learn how Jetty improved credit underwriting without risk.

2. Diversify data sources to open up new customer segments

Being conservative isn’t inherently bad. However, banks and fintechs shouldn’t lose out on good borrowers by being overly cautious.

The reality is that 5.9 million households in the United States are unbanked. If a customer with a slightly below-average credit score or limited credit history is interested in banking with your organization, accessing additional information could help you better understand their financial health. This way, banks and fintechs can both avoid bad debt and offer credit to customers they might have otherwise denied. In fact, many banks and fintechs are already considering alternative data sources to verify thin-file applicants.

"A growing number of FIs utilize alternative verification methods to achieve this goal. Some FIs utilize data from a third-party credit bureau and authenticate it based on the local country's requirements. Others use document verification tools to verify an applicant's foreign passport or driver's license and behavioral biometric data to identify potentially fraudulent applicants," said Alloy co-founder and CEO Laura Spiekerman.

How Alloy does it

With thin-file applicants, the challenge is often not having enough information about an applicant’s financial history to make safe lending decisions. Alternative data can alleviate some of those concerns, helping lenders consider applicants they might not have otherwise.

To that end, Alloy integrates with best-in-class data sources to enhance credit evaluation. That includes not just credit bureaus but sources of alternative data like cash flow, business financials, and utility payments. This gives underwriters a clearer picture of creditworthiness so that they can make confident, inclusive credit decisions.

For instance, a newcomer to the U.S. might have a low credit score or limited credit history, which could make a bank or fintech hesitant to consider their application. However, alternative data could reveal that they consistently make utility and rent payments, reflecting their reliability and supporting their creditworthiness. Depending on the credit product being applied for, this and other alternative data could be enough to assure a lender that the benefits of extending credit outweigh the risks. And it can do it without compromising compliance.

Explore ways you can offer credit to a broader audience.

3. Develop agile credit risk policies

Since 2020, the economy has transitioned from expansion to recession and now to inflation. To weather the market's ebbs and flows, banks and fintechs need agile credit risk policies that can keep up. If credit checks are only conducted at origination, there are missed opportunities to protect against default risk, extend new credit offerings, or reward good financial behavior. Conducting credit checks at regular intervals helps banks and fintechs adjust to a customer’s financial circumstances, whether they are doing worse or better than when they were onboarded.

However, many banks are still stuck with legacy technologies that prolong decision times, are complex to manage, and have limited automation. These systems lack the flexibility to adapt to evolving credit models quickly. It’s not uncommon, for instance, that for every policy change, a bank working with legacy technology needs developers to jump in and change the source code.

According to Deloitte, due to years of underinvestment, current core banking systems can't keep up with newer technologies:

"They're simply not capable of supporting the market's rising expectations and may soon expose banks to additional risk and liability. Also, operation and maintenance of those legacy systems is becoming more difficult and costly thanks to the small and dwindling pool of experts with the technical and institutional knowledge to support core systems developed for a different era." – Ed Quinn and Bob Hirsch, Managing Directors at Deloitte Consulting

How Alloy does it

However, Alloy transforms this process. With Alloy Credit Underwriting, banks and fintechs can also quickly adapt their credit policies at any point throughout the customer lifecycle to match economic conditions by changing a customer's interest rate, credit limit, or credit term length — without requiring engineers.

With Alloy's comprehensive Testing Suite, banks and fintechs can iterate various credit models to identify improvements within their credit underwriting process. For example, they can perform a what-if analysis with back tests to assess the potential impact of each decision before committing to them.

Alloy is built with financial agility in mind.

Learn about the Alloy Testing Suite

Best way to manage credit risk in uncertain times? Stay ahead

When the economy is unpredictable, proactiveness wins out of all the credit risk management best practices. Alloy helps many banks and fintechs solve their credit underwriting challenges swiftly and seamlessly. If you're interested in seeing Alloy in action, schedule a demo.

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