Author: Merili Kiipus
Matters concerning evaluation of the creditworthiness of consumers have returned to the focus during the last year. Discussions revolve around consumers’ increased loan burden and share of loans in default; there is lobbying for additional support from the establishment of a positive credit registry, and the Financial Supervision Authority has started getting tougher with fines on market participants who don’t abide by the rules.
The need and nature of consumer credit checks remain unchanged – loan providers have the duty to collect and evaluate information on a loan applicant’s incomes and (financial) obligations; relying on self-reported information and results of queries to internal and external databases. It’s important to be in conformity with the principles of responsible lending stemming from the Creditors and Credit Intermediaries Act[1] and to enter into a credit agreement with an applicant only if, as a result of analysis of financial reliability, the credit provider is certain that the consumer will be able to pay off the loan on the agreed upon terms without winding up in financial difficulty.
This is certainly not just a unilateral obligation where the creditors should be saddled with the entirety of the responsibility for freighting a consumer with excess debt burden. It is no less important for the consumer themselves to submit true and comprehensive information and to evaluate their own ability to pay the existing and additional financial obligations as required. Still, even though responsibility should be shared, there is much that credit providers can do to improve the general state of the market and take a small step closer to the consumers if, in certain cases, their borrowing needs to be slowed down.
We’re long past the era where an employee would pass judgment on a consumer’s creditworthiness after a detailed analysis of the applicant’s bank account statements and other supporting queries. Competition is stiff, pressure from market participants is high and the applicant’s creditworthiness has to be evaluated in real time for a good customer relationship to be established and maintained. Nowadays, creditors use, one way or another, various automated systems and algorithms to do the analysis and make the credit decision instead of a human.
On one side you have laws and regulations and internal procedure rules established to implement them, and obligatory requirements are being fulfilled on their basis, but on the other side, we run up against the hard reality that automated systems only help human creditworthiness evaluators to a certain degree. Beyond that point, the system isn’t capable of considering some important, even critical nuances. Often a system will be able to weigh parameters separately but the problem arises when the assessment has to be provided as a combination of various indicators. As a result, there can be undercompliance or non-compliance with some key conditions and obligations under law, since to get results, you often need additional assessments that may prove too complex for an IT system.
True, credit providers have a legitimate expectation to proceed from the principle of proportionality based on the loan amount applied for – i.e. a lower amount and lower risk require less analysis. The risk is when the IT system is unable to distinguish between the criteria and all loans end up being analysed based on the “lighter criteria”.
Credit providers establish their own methods for analysing financial reliability and ensuring that all compulsory criteria can be integrated into and made operational with the IT system being used. In our work, we often come across situations where certain important aspects of use of IT solutions are (partially) left uncovered and/or there are certain errors made in the combined effect of all actions:
The IT solutions are often given broad discretion, and when contradictions come up, the explanation given is that an IT system can’t in fact take all factors into account. Understandably, it can’t and it doesn’t; thus it is all the more important to ensure that the methodology for rating customers stems from the law as much as possible, that it is thought thorough and clearly described in the internal procedure and has both content personnel and IT developers work together.
In regard to aspects that are beyond the capacity of the system, alternatives must be found to ensure that the applicant’s creditworthiness has received an adequate evaluation. This in turn presupposes a very clear understanding of how things should work and how they actually work. The “tasks” assigned to the IT system must be described such that a bystander would understand how it works, what information which conclusions are based on and how all of the above, and the task, can be updated where necessary.
Modern IT solutions must be the foundation but there should be great attention paid to fulfilling the requirements of legislation and making sure that the consumer’s financial reliability has been analysed and evaluated as required.
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