Problematic debt – A big taboo in search for a Fintech solution

28 April 2023

Taking on debt is not necessarily a bad thing, especially when debt is used to generate wealth, but in the current cost of living crisis, debt can easily spiral out of control. With an ever-increasing number of people struggling to pay off their bills and debts, problematic debt is a major concern.

Unfortunately admitting to debt problems is still a taboo. As a result debtors rarely seek support for their financial difficulties before it is too late. At the same time creditors also struggle to find the right balance of dealing with this issue in both the credit origination and debt collection process. In the credit origination process creditors are expected to be inclusive and offer a credit as often as possible, but at the same time creditors should be sustainable (i.e. apply Responsible Borrowing) and not push people into debt. If you combine this with the fact that creditors are business that at the end need to make money and you get a very slippery slope. The same applies for the debt collection process. Obviously every creditor needs to ensure debt is properly reimbursed (as this is the foundation of a healthy credit market), but at the same time this should be done in a sustainable and ethical way and with respect to all legal requirements (data privacy, fair lending practices and consumer protection), while keeping a good customer relationship with the debtor at any step of the process. Often this is easier said than done.

The solution to these taboos and dilemmas may be technology, as it offers a quick and non-judgmental way to educate and support people struggling with debt.

Technology can help during the four key phases which lead to problematic debt:

• The origination of the debt
• The (first) reimbursements of the debt that are still executed correctly in time
• The identification of the (first) missed reimbursements
• Defaulting on a debt and executing the debt recovery process

Let us have a look at these four steps and how technology can help people better manage their debt.

1. Credit Origination: in the credit origination step, a creditor should ideally assess if the debtor is able to afford the credit (affordability check) and if the credit purpose is to improve the financial situation of the customer and not to worsen it. When a person does this assessment, this can feel very paternalistic, but via digitalization, this can be organized in a different way.
   • Transparency: the first step in responsible lending should be full transparency provided by the creditor about the credit. This means offering clear terms and conditions (e.g. no hidden costs) and a clear explanation of what the impact of certain scenarios is (e.g. changing interest rates, issues with the underlying objects like theft or damage, personal changes like loss of job, divorce, etc.​).
   • Affordability check: currently the credit scoring is still too much based on your credit history (the past) and not enough on checking the affordability (forward looking towards the future). Often banks have perfect insights (and if they do not, they can obtain it via PSD2) in the full history of the income and expenses of the debtor. This allows to generate a good idea of how much credit the customer is able to reimburse, but it also allows to generate a spending pattern of the customer (based on a classification of the customer’s expenses in essential and non-essential spending).
   • Improve financial education: by offering well-made videos and interactive tutorials the financial knowledge of customers can be improved, i.e. understand better how credit works and how to manage their finances effectively. A creditor could even force customers to follow a certain training before a credit is granted or can provide a discount on the interest rate if a training is followed.
   • PFM Tooling: via user-friendly PFM tools (Personal Financial Management) expenses can be easily classified and tracked and budget plans can be defined. This gives the customer a much better understanding in their personal finances. Just like in the previous point, a customer could be given a discount on their interest rate, if they have been using the PFM tool for a certain duration before applying for a loan or if they commit to use the PFM tool during the credit’s life-cycle.
     Via such a PFM tool the creditor can evaluate the customer’s expenses and identify if a provider switch (e.g. telco or electricity provider) would not be opportune or indicate on which expense categories the debtor is paying too much compared to people with similar income and family situation.
   • Insurances: often debt problems are the result of other issues, e.g. health issues, unexpected costs, job loss, divorce, etc. Customers can often insure themselves against the budgetary impact of such events. During the origination process a creditor can therefore make an automatic analysis of the customer’s insurance situation and identify potential gaps. As part of the credit origination process, the creditor can provide a personalized impact analysis on how the missing insurances could impact the financial situation of the customer. Additionally creditors can force certain insurance(s) before accepting the credit or offer discounts, as the risk of defaulting can be reduced thanks to additional insurances.
   • Simulators: provide tooling to help debtors better understand their reimbursement capacity, but also to find the best possible financing product (cfr. FINE module of Capilever) and the best possible interest rate scheme. For example, the customer can simulate how a variable interest rate scheme can evolve over time when central bank interest rates change, but also with changing inflation (cfr. CompaRate module of Capilever).
   • Balance out financial imbalances: customers have to deal with strongly fluctuating expenses on the short- (e.g. lot of expenses at beginning and end of the month), medium- (e.g. lot of expenses in the month of September and October) and long-term (e.g. period of children going to childcare or to high school). Banks can offer products to balance out these imbalances in expenses in the short-, medium- and long-term (cfr. FLEX module of Capilever).
   • Government support: creditors can assess if the debtor is enjoying all governmental support to which he is entitled. If certain gaps are identified, the creditor can provide explanation on how to apply. Such support aid can obviously improve the debtor’s reimbursement capacity and thus reduce the credit risk for the creditor.
   • Pay-out of the credit: instead of paying out the credit in cash, it might be interesting to pay-out the credit in a sort of voucher (niche money), which can only be used at specific merchants and/or for specific products. This way the creditor can better control on what the borrowed money is spent.
   • Chatbots for Customer Support: chatbots can be used to provide 24/7 customer support to borrowers. This can help reduce wait times and provide borrowers with quick and accurate answers to their questions about borrowing and credit management.
2. Reimbursement of the debt: usually customers will pay the first reimbursements in time, but after a while problems might start to occur. Currently banks only start acting when the first missed reimbursements occur, while it would be much better to continuously monitor the financial situation of the debtor and already predict potential problems upfront. This would allow the debtor to react much faster before the situation worsens.
   • Setup automatic payments: once the credit is activated, the creditor should automatically set up automatic payments (or a Direct Debit if the feeding account is located at another financial institution) to avoid missing any due dates.
     Even in case of automatic payments, the creditor should inform upfront the reimbursement amount that will be debited. This way the customer is reminded of the debit and can prepare for it. If at the moment of sending this communication, it is identified that there is insufficient balance on the account, this should also be communicated, so that the customer still has time to adjust the situation.
   • Continuous affordability check: today an affordability check (if done) is only performed at the origination of the credit, but ideally a creditor should re-execute this check (in an automated way) on a recurring basis, as long as the credit is not fully reimbursed. This allows to identify potential credit issues, even before they start occurring.
   • Support people for whom potential credit issues are predicted: this continuous affordability check combined with data analytics identifying certain patterns (e.g. making minimum payments on revolving credits or regular credit balance transfers) can identify potential future issues. When such issues are predicted, a tailor-made personalized solution should be proposed to the customer. Examples could be recommending to stop non-essential spending or pro-actively offer adaptations to the credit (e.g. pausing, extension of duration, aligning the monthly reimbursement date better with the salary payment date, etc.).
   • Gamification: gamification can be used to make the debt repayment more engaging and motivating for borrowers. This can include reward systems for on-time payments, leaderboards for successful repayment and progress tracking tools that show borrowers how far they have come in paying off their debts.
   • Automatic rewriting: automatically identify if a rewriting of the credit is beneficial for the customer. If so, notify the customer with a calculation of the gains that could be made, but also a simulation of all the penalties and extra costs involved in rewriting the credit.
   • Reward customers for correctly reimbursing their debt: customers could also be incentivized for reimbursing their loan in time over the whole credit life-time, via a bonus or gift at the end date of the credit.
3. (First) missed reimbursements: as soon as a reimbursement is missed, fast action of both the creditor and debtor is essential, to avoid additional costs and ending up in a debt spiral. Concretely this means that a creditor should take following actions:
   • Immediate notification of the customer about the missed payment via an automated process. Via the usage of AI, the communication should be adapted to have maximum success to attract the customer’s attention, i.e. choice of communication type (e.g. email, SMS, voice messaging, letter, phone call, in-app notification, WhatsApp message, etc.) and style of the message (formal, professional, informal, etc.).
   • Personalize the message(tailored communication strategy), i.e. depending on the situation of the customer, include in the message:
     • Explanation of the potential future impact of not properly reimbursing the credit, i.e. the impact on your Credit Scoring, which can haunt you for the rest of your live.
     • Provide one-click actions to pay the missed reimbursement, i.e. prepopulated payment instructions from account(s) still having enough money (potentially a split payment from different accounts), automatic selling of certain financial assets and immediately recovery of the money, offer possibility to setup a Direct Debit mandate, etc.
     • Provide one-click actions offered by the bank to review the credit in order to support the customer, e.g. pausing the credit, extending the duration of the credit (resulting in lower reimbursements), repackaging of existing credits into one (cheaper) credit (i.e. debt consolidation).
   • Refer the customer to specialized services, such as government support or non-profit organizations that can provide individual support and help with budget management.
4. Defaulting on a debt and the resulting debt recovery process: creditors often have outsourced this phase to specialized credit collectors, but this also means that the relation with the customer is lost and a long-term relation becomes more difficult. In any case the creditor or debt recovery agency should take following actions:
   • Automatic blocking (and selling) of assets at the creditor.
   • Automatic ceasing on salary deposited on a current account at the creditor.
   • Setup a tailored (personalized) plan for reimbursing the credit. By using predictive analytics (e.g. using data on behavior, payment history​) the most effective strategy for recovering debt from a defaulter can be identified. Once a reimbursement plan is proposed and agreed, the necessary automated payment instructions (potentially rule-based) can be setup.
   • Collaboration and Partnerships: debt collection agencies are increasingly collaborating with other organizations, including banks, credit unions, and fintech companies, to provide more comprehensive debt recovery services via the sharing of data.

Overall, technology can bring significant improvements to credit management by providing users with more tools and resources to manage their debts effectively, and by enabling creditors to create more accurate credit scoring models and more personalized and effective solutions for borrowers struggling to repay their debts.