Cost efficient risk strategies during times of unpredictable inflation

Andrew Bailey is under pressure. While there’s been progress in getting UK inflation down, it’s too early to declare victory. Cut interest rates too soon and too rapidly—and risk a resurgence of price pressures. Wait too long—and do unnecessary damage to the economy, consumer affordability, and labour market.

At the same time, geopolitical risk, market volatility and economic uncertainty are making forecasting and planning extremely difficult for 2024 and beyond. All of which leaves lenders navigating through a period marked by unpredictable inflation.

This presents a challenge for the credit industry. One that requires a strategic pivot towards more comprehensive and cost-efficient risk management practices.

Let’s get into it.??

The impact of inflation on lending and risk

CPI in the UK rose to 4% in December from 3.9% the month before—yet far below the levels exceeding 10% that it reached a year earlier. However, given continued world events, it’s expected the BoE will acknowledge progress while pushing back on the notion it was about to start aggressively slashing interest rates.

Fluctuations in inflation have a tangible influence on both interest rates and the broader credit market, creating a ripple effect that affects lenders and borrowers. For lenders, this unpredictability introduces heightened risk.??

Moreover, inflation changes can erode the real value of things like collateral, making secured lending riskier. Properties and assets that serve as collateral may be harder to value, posing a challenge in risk mitigation.

And that’s not all.

The unpredictability of inflation adds another layer of complexity. Traditional risk models may not be as effective in forecasting future trends under these volatile conditions. And gaps in data from your chosen bureau may create blind spots.

According to risk.net , Kelli Sayres, Senior Managing Director and Head of Product at Numerix, believes lenders need to become more comfortable with the fact than inflation will remain volatile throughout 2024; “Firms are looking at how their inflation risk measures up, [whether] they have [effective] hedges against it, and what it does to their day-over-day and month-over-month profiles,” she said.

This comes at a time when funding levels are high and loans on the asset haven’t necessarily been adjusted.

Much like during a recession, lenders must navigate these choppy waters with strategies that not only address current challenges, but are also flexible enough to adapt to future market shifts.??

But there are strategies that can help. For instance, by leveraging data benchmarking, lenders can save costs on data and gain a more comprehensive view of customers—all of which work to lower lending costs and boost consumer protection. (More on this next.)

Leveraging data benchmarking for data cost savings and comprehensiveness

At a time where margins are so tight, lenders must find innovative ways to optimise costs without compromising on the quality of data. Data which is crucial for making informed credit decisions.

This is where data benchmarking comes in.

It allows credit providers to compare and contrast the data quality and pricing offered by various credit bureaux, creating a more competitive and transparent marketplace.

But, as we’ve talked about it at length , data benchmarking is more than just a cost-saving exercise. It's a strategic approach. By providing a clear insight into how each bureau measures up against others in terms of data quality and cost, benchmarking empowers lenders with the evidence to negotiate fairer prices at the same time as improving data quality and comprehensiveness.

??In a market where we've seen prices significantly inflated, this can lead to substantial savings.??

Aside from the obvious savings, benchmarking ensures lenders are using the best quality data for accurate affordability assessments and responsible lending practices.

In fact, just in 2023 alone, several banks and financial institutions have reported substantial savings—ranging from 23% to 50%—over contract periods using data benchmarking strategies. And these savings are not just one-off gains; they are often recurring, impacting the bottom line significantly over time.

Data benchmarking the basics

We cover everything you need to know about data benchmarking here , but if you need a quick run-through, here’s a quick summary.

Essentially, the process of benchmarking involves four key steps:

●????? Engaging with the current data landscape to understand existing sources and costs;

●????? Comparing these findings with the market to identify discrepancies;

●????? Recommending target pricing based on this analysis;

●????? Supporting the negotiation with suppliers to achieve these targets.

This methodology not only assures cost savings but also ensures that the quality of data is not compromised in the pursuit of lower prices. Of course, another approach to help lenders is multi-bureau, which we’ll take a look at next.

The option of multi-bureau?

Sometimes, having more than one bureau is a strong option. After all, the value of what each bureau offers depends on the quality and coverage of the information they hold on individuals.

Plus, with the FCA identifying “significant differences in the credit information held by the three large CRAs” - information that is particularly important to a lending decision - there are strong reasons why lenders often adopt a multi-bureau approach. (You can read more on how lenders decide if to adopt multi-bureau or not here .)

The key advantages of a multi-bureau approach

Firstly, multi-bureau mitigates the risk of missing or incomplete data. Each credit bureau may have different pieces of information about a consumer. By combining these varied data sources, lenders can achieve a more accurate and complete view of a borrower's credit history and behaviour.

It’s a major value-add, especially for managing credit risk effectively during periods of economic uncertainty, like those driven by inflation.

Secondly, multi-bureau aids in identifying discrepancies and anomalies in credit reports. Inconsistent information across different bureaux can be a red flag, indicating potential issues such as fraud or errors in credit reporting. By using multi-dimensional data analysis, lenders can more effectively spot these inconsistencies, thereby enhancing the overall quality of their credit risk assessment.

However, if you’re on the credit risk or procurement side of things, I bet I already know what you’re going to say about this.

●????? “It’s too hard to switch”

●????? “Multi-bureau is too expensive”

●????? “Multi-bureau is not important enough”

Guess what? This just isn’t true. You can adopt a multi-bureau strategy without paying full price for two-three bureaux. The fact is, while some bureaux will typically try to increase prices if a lender reduces volumes so that they can work with a secondary or tertiary supplier, this shouldn't be the case.

From our extensive work in this space, we know that other lenders are already receiving lower pricing for lower volumes, therefore you too can get fair market rates by benchmarking and challenging the bureaux to replicate the discounts they are offering others.

In fact, you’ll find that some of the bureaux provide packages that are actually designed for lenders who require a multi bureau approach. The difference in these packages includes flexible usage between contract years, lower minimum commitments, and graduated pricing dependent on volume.

As an interesting side note, larger lenders who have high volumes of business are not aware that smaller volume users are benefiting from much better pricing. Some large lenders have already adopted multi-bureau, however, different bureaux are being used in different divisions on different platforms within the company and the lender is unable to switch usage easily, hence pricing has remained high.

The key takeaway is: There is a huge opportunity for lenders large and small to negotiate better rates. You just need to improve your buying power. And in an environment marred by inflationary unpredictability, this comprehensive approach is essential for making well-informed, prudent lending decisions.

Adapting to future challenges

During times of unpredictable inflation, economic and geopolitical times, the lessons are clear: proactive and cost-efficient risk management is imperative for lenders. The strategies discussed, from leveraging data benchmarking to adopting a multi-bureau data approach, have proven their worth in enabling lenders to make informed, strategic decisions while managing costs effectively.

Looking ahead, throughout 2024, the key for lenders is to remain agile and adaptable. By combining cost-efficient risk management practices with a forward-looking mindset, lenders can not only withstand current economic uncertainties but also lay a strong foundation for future growth and stability.