Improving analytics, dealing with the rise in delinquencies and moving to centralized decision management are among the top priorities for banks in the current credit crisis. Those are among the key findings of a new survey among leading banks, performed by TowerGroup, and presented for the first time at Fair Isaac’s InterACT conference in April.

TowerGroup, a leading research and advisory services firm, undertook the survey to assess the state of decision management in the US banking industry. The survey targeted senior risk management and credit executives at the top 50 US banks and credit card issuers, and included a robust 108 participants. Theodore Iacobuzio, managing director and practice leader for payments at TowerGroup, shared the results at InterACT.

The survey comes at a trying time for financial services, when conventional notions of risk are being turned on their head in some areas. This makes sharper risk management more imperative.

Iacobuzio posed the question, "Who would you rather have as your customer? The guy who misses three mortgage payments a year but is always going to be good for the loan in the end, or the guy who makes his mortgage payments on time 12 months a year? Well, the answer is obvious. It's the first guy.

“But that has changed in the past six months. Some of these ‘good risk’ customers will remain in that bucket, others will move into a riskier bucket, and others will move into a very risky bucket indeed. So who are these people and, more importantly, what do you do with them when you identify them?”

Iacobuzio noted strong growth in credit card receivables as the mortgage market crumbled. “It's our thesis that growth is being driven back into credit cards, not necessarily at the point of sale, but from home equity. Therefore, a certain percentage of those receivables are going to be toxic in nature. The challenge for institutions is identifying those receivables that are toxic, bucketing them appropriately, and coming up with actionable strategies for dealing with them.”

Challenges more severe for larger institutions

The survey showed that large and small institutions feel the impact of the current economic environment in the US very differently. One third of all respondents saw the situation as a “systemic threat” or “severe challenge,” while 55% consider it a “manageable setback.”

TowerGroup believes that larger institutions were more likely to characterize the impact of current economy as a systemic threat or severe challenge because they took on more risk in past years. They may have written some of the riskier loans, and may have invested in instruments these loans were behind. The smaller the institution, the less likely that is the case.

“The large institutions are the front line,” says Iacobuzio. “So smaller institutions may be in a better position to weather the storm. The question is: Does the wave continue to break, and will small institutions feel the effect as it goes through the larger economy as a whole, no matter what their lending or investment strategies may have been in the past?”

Delinquency having biggest impact

While the current economic conditions pose a long-term problem, the survey also identified short-term fires that lenders need to put out. The majority of respondents, at 55%, identified increased delinquencies as the biggest impact of the credit crisis. Charge-offs and loan reserves have also been affected, and there has been a general escalation of credit risk, according to nearly half of the respondents.

As delinquencies and charge-offs continue to increase, TowerGroup believes that credit policies will tighten. However, as financial services institutions become more conservative about risk, they can negatively affect their profitability.

“Unless you’re able to decision intelligently, the tightening policy may have a paradoxical effect on the institution,” says Iacobuzio. “Your business may suffer; your profitability certainly will.”

TowerGroup believes that these environmental factors accelerate the trend to building profitability by managing customers already on the books, rather than acquiring new ones. Existing customers have more predictable performance, and lenders can more easily affect their behavior.

An integrated view of the customer becoming more critical

Nearly 70% of the respondents feel it's critical or very important to have an integrated view of customer information. TowerGroup believes that most institutions have already taken the first steps with earlier CRM initiatives, and have already normalized their data. The challenge becomes executing profitable action plans based on that customer information.

“Most banks have a pretty good grasp of who their customers are and what products they have,” says Iacobuzio. “The question is: Are you able to develop a strategy and decision out to the touchpoints, so that you can act on the knowledge you have? That’s the task 10 years on from CRM, in our opinion.”

Nearly 80% of respondents believe it will become more important to have an integrated view of customer data in the next two years. It is TowerGroup’s opinion that as times get worse, an integrated view of customer data will become “absolutely essential for even surviving in this environment.”

Analytics are top priority for improving decisions

In the next 12 months, 75% of respondents are planning to improve their analytics to enhance decision making. TowerGroup believes this is a logical evolution: After data normalization has been accomplished, the next crucial step is improving analytics. If the business has changed, the analytics need to change.

“This shakes down in every conceptual category you could think of,” says Iacobuzio. “For instance, in the credit card business, loyalty and rewards programs have always been employed to drive spending. But some progressive issuers are beginning to use these programs to encourage prudent spending, and ensure the customer is borrowing in a way that helps the account remain a true asset for the institution. The analytics that are needed have to change as well.”

Decisioning across the enterprise

The survey showed that respondents tended to have one main decisioning system per functional area, rather than a universal decision system spanning multiple areas. Most felt that these siloed decision systems were meeting current needs, but would not support them adequately in the future.

In fact, 80% of respondents said it is critical to make connected decisions across product lines and throughout the product lifecycle. “A single decision management system needs to be in place for that,” Iacobuzio noted. “To keep areas such as optimization, risk management, compliance or collections confined to one product silo in this environment is, we believe, very dangerous.”

Large financial services institutions tended to view enterprise decisioning as a slow, complex process to establish. However, they may also be more convinced of its necessity, because of the negative impact they’ve been seeing on a quarterly basis throughout the current credit crisis.

“Enterprise decision management becomes extremely, extremely important for banks, because it becomes a competitive issue. Those who are ahead of you in implementing a unitary decisioning model across product lines and across time—in other words, across the lifecycle of the loan as well as across the different kinds of loans—are going to have a very significant competitive advantage over those who are implementing currently or those who are just beginning to implement.”

Other findings from the survey include:

• 60% of respondents view predelinquent calling as somewhat or very successful. “I think 60% is pretty low,” says Iacobuzio. “This is an area where institutions that have not moved forward will probably want to take a serious look.”
  
• 76% of respondents have moderate or strong coordination between risk and finance. “This is an excellent percentage and very positive for the industry,” says Iacobuzio. “However, the quality of the coordination is really where the rubber meets the road. This is where decision management can be a very strong tool.”
  
• 36% of respondents said increased decision complexity is the biggest impact of Basel II on decision making. In TowerGroup’s opinion, increased decision consistency is an intended implication of Basel II, and will make it easier for financial institutions to monitor results and make adjustments in the future.
  
• Except for a small minority, optimization techniques are not used enterprise-wide. “Up to now, financial services institutions may not have needed to use optimization techniques on an enterprise level,” Iacobuzio said. “This becomes another area where integration across product lines and through time becomes extremely important. In this current crisis, we believe that financial services institutions will begin using optimization more widely as they explore techniques to manage risk and identify revenue opportunities.”

Iacobuzio concludes, “Financial services institutions perceive the need for integrated customer information and multiproduct decisioning, because the environment is demanding it. Their immediate needs are delinquencies and charge-offs, but while putting out those fires, they need to help determine longer-term needs as the environment continues to worsen.”

Download the presentation: TowerGroup Survey–Universal Decisioning in Turbulent Times.

View the recording of an exclusive webinar by Theodore Iacobuzio, presenting the TowerGroup survey.