COVID-19 and Personal Credit: A Mixed Impact

As the Coronavirus silently creeps the world, financial markets tremble. With the rise in online loan applications, banks, Fintech operators and financial institutions are starting to tighten approval requirements protecting their risk exposure. Some go further, in the face of the current uncertainty and with the 2007-2009 recession still close enough to remember candidly, they have decided to retreat awaiting more favourable times under which to operate. 

For example, Ferratum (Ferratumgroup.com) was the first Fintech lender to land in Spain offering payday loans (microcréditos) over mobile SMS starting back in December 2008 under the commercial brand Creditomóvil, only a few years after their very first market was pioneered in Finland. Later in December 2011, Ferratum brand was introduced with a slightly more sophisticated technology allowing customers to apply for loans over the internet by filling out an online application form that usually takes a few minutes.

Under the direction of Ricardo Gonzáles (2011-2016), Ferratum failed to leverage the opportunity laid by Creditomóvil as a first-mover. Not surprisingly, five years of clumsy direction and missed opportunities led to the dismissal of Mr González. To date, Ferratum had never locked sufficient footprint in Spain, probably now fuelling its departure.

Other lenders fearing high defaults have stopped offering loans to new applicants or simply abandoning the market as is the case with Freezl, Wandoo Finance Group and CCLoan, according to rumours.

How the coronavirus is impacting personal credits

Luis de Guindos, the Vice President of the European Central Bank, and other financial experts predict a "deep recession" due to COVID-19, and many people worry not only about the future, but also about the present. The state of alarm declared on March 14 has confined millions of Spaniards in their homes, causing many of them to be unable to work temporarily, yet many fear there will be no jobs to go back to when the lockdown is lifted. How are they going to be able to feed their families, or pay their rent without receiving any income? State aid is not yet arriving or is insufficient and many people are beginning to apply for a personal credit or a loan not knowing for real how will they pay back.

The financial sector is suffering a critical setback overall. On one hand, it is necessary to take into account that applications for traditional credit is being reduced due to the impossibility of accessing certain products or services right now. No one —or almost no one— is thinking about buying a car or booking a trip for example. On the other hand, online financial services are growing exponentially during the pandemic, which has led many Spaniards to turn to online loans and their star product: the microcredit. We only need to look at the Google Trends results of the last few months to see the increase in searches for online financial services.

Credits to Neil Patel

Thus it seems the pandemic has driven the general public to focus their attention on the digital space and the many opportunities it offers helping soften the unfavourable fame with which Fintech lending firms are often associated with. Online lenders are known for facilitating credit, an all-digital paperless service that requires no collateral, yet, being approved for an online loan involves a rigorous credit scoring that entails customer's affordability check to determine their credit-worthiness. This distant and impersonal service comes at a cost for the lender whose credit losses can be drawn well above 20%, whereas in the traditional brick-and-mortar banking losses gravitate around 3.5% in the good times.

However, COVID-19 has brought a very different environment to our doorstep. According to a Barclay's report, major banks in Spain will suffer a 67% increase in delinquencies in the next three years accounting for over 50Bn. Bankia alone will likely face defaults amounting to 6,5Bn or 6.4% of its total credit investment.

More specifically, the report mentioned in EL Economista indicated that in Spain the number of non performing loans of Santander, BBVA, CaixaBank, Banco Sabadell, Bankia and Bankinter will grow by almost 50Bn altogether during this three years period. In this way, according Barclay's analysts, Santander's delinquency ratio will reach 6.6% (now set at 3.3%) and BBVA's will reach 6.9% (currently 3.8%) toward the end of this exercise.

"Bankia alone will face defaults amounting to 6,5Bn or 6.4% of its total credit investment."

According the a recent article published in the Financial Times, US and and EU banks are on track to set aside more than $50Bn in high-risk loans in this 2020's first quarter, the largest of such provisions since the 2008-09 financial crisis, and an indication of the serious economic damage caused by the coronavirus.

Different banks have dramatically different approaches across the industry, raising questions about how rigorous or negligent some banks are in evaluating potential future losses.

Among the largest institutions, US banks seem to have taken the baton, they are argued to have been most cautious, increasing their reserves for possible bad loans by 350 percent from the first quarter of last year to $25Bn, while European lenders have increased provisions by 269 percent to around €16Bn.

HSBC, Europe's largest bank by assets, was the most pessimistic tone during its presentation of results, with $3Bn in initial provisions and warning losses could reach $11Bn this year. A notable outlier is Deutsche Bank, which provisioned just €500M in the first quarter, compared to ￡2.1Bn at British rival Barclays.

?The Impact of the coronavirus on the personal loan market

The COVID-19 crisis does not recognise borders. The global closure is severely affecting the personal loan market in all the territories where online loan products are usually consumed. Despite the rise in searches for personal loans online, as stated by a Google search analysis, some financial operators with an international footprint claim a contradictory double effect: a decrease in the demand for personal loans and a decrease in loans issued to their customers.

"Some financial operators claim a contradictory double effect; a decrease in the demand for personal loans and a decrease in loans issued to customers."

Asia - Favourable Outlook

Remote financial services have increased as a result of the pandemic. Among these services, online financing solutions are the most demanded, occupying 23% of the digital searches carried out in Vietnam, the Philippines, Indonesia and India. In addition, other products that have increased in popularity in recent weeks have been e-commerce, digital payments of utility bills and online banking apps, as well as mobile and digital wallets.

Likewise, the demand for financing through Fintech operators has also increased significantly. Thus, in Vietnam for example the request for these services has increased by 38%, while in Indonesia it has risen by 52%. The increase has been more moderate in India; by 7%. However, at the same time, the report claims that the global confinement and isolation measures have slowed this trend however.

Australia - Little Changes

Coronavirus is having less impact in Australia. Although measures and controls have been imposed, they are not as severe as those of another countries. In the island the demand for personal loans remains high and responsible loan criteria are expected to focus on income stability in the coming months.

United Kingdom - Small Contraction

In the UK personal loan applications have been reduced from 30% to 40%. Experts point to economic uncertainty and the loss of consumer confidence due to job insecurity as the main causes. Articles traditionally purchased through credit are currently inaccessible because of the isolation measures.

It is to be expected that UK lenders would also limit their supply of credit. In addition, similarly as what is happening in Spain for example, some of them have paused their loans entirely, while others are restricting loans to self-employed consumers or clients working in high-risk sectors, such as tourism and hospitality.

On the other hand, on April 2 the FCA proposed some temporary measures to help operators of financial products. Some of their proposals include temporary freezes on payments on loans and credit cards.

Poland - Riski and Uncertain

Poland has suffered the effects of COVID-19 with less intensity than other European countries. The fast governmental intervention closing schools and borders in early March was the key to stopping the spread of a virus that seems unstoppable. However, limitations on the movement of people have put the country in a state similar to the total lockdown of other regions, such as Spain, France or Italy.

One of the measures imposed by the government has put a limit on the rates that lenders can charge for new loans. The direct consequence has been a temporary shutdown of most loan services while they update their systems and products to reflect the new limits. Some lenders are expected to have to withdraw from the market, which will surely increase pressure on the supply of personal loans in Poland.

Spain - Volatile

Thus, the data is bleak, according to Expansion in an article by José María Rotellar, Spain is on its way to a severe recession with a fall in quarter-on-quarter GDP of 5.2%, compared to growth of 0.4% in the fourth quarter of 2019. Employment, in turn, fell by 5% quarter-on-quarter, and if we measure it in terms YoY the results are also appalling, with a drop in GDP of 4.1%, when in the same period of the previous year it grew by 1.8%.

In other words, Spain is probably entering a strong recession according to the experts—which could lead to depression if we don't do things right—massive unemployment and falling prices, an element that could complicate the payment of personal loans, not so much for their interests, which would continue to be low on renewals in those circumstances, but for the greater real value that their principal would have, an element that could hinder their returns for sure. The situation gets even more complicated for online operators who are require to act fast in an uncertain environment where risk management is deemed paramount for the continuity of their business.

United States of America - Uncertain Times Ahead

The pandemic is hitting the United States very hard. The confinement measures have had immediate disastrous effects on the American economy and unemployment figures. To alleviate this financial crisis, the US government has approved the CARES act, establishing itself as the greatest economic stimulus in modern history.

In this environment, US lenders have been limiting their number of clients since mid-March. Their main concern is non-compliance and continuing to support their clients in the coming months. Likewise, the demand for personal loans has also decreased in the US due to the loss of consumer confidence and the inability to purchase certain products and services right now, such as cars or houses.

The tightening of credit conditions due to the coronavirus

However, at the same time that people suffer the effects of the coronavirus crisis, financial companies are hardening access to traditional loans. Among other measures, income verification systems are being strengthened and the available credit in newly issued loans and cards is being reduced in what some might refer as a risk management move.

In addition, as reported by the Wall Street Journal, emails offering loans for individuals and small businesses have also been significantly reduced. Furthermore, some financial institutions are helping their clients by offering a delay in the due date of their products or an increase in the spending limit. Other lenders, lacking creativity to investigate the level of risk in this new scenario, have stopped offering loans to new potential clients. Others have simply decided to initiate a process to abandone the market as is the case with Ferratum who recently decided to stop consumer lending services in Spain.

"Thousands of Spaniards wonder how they will get ends meet now."

In other words: the scene is more problematic for those trying to access credit now. This is happening because financial agents fear that the default rate on unsecured loans will skyrocket due to job loss and the impending recession that is already beginning to spread its tentacles across the globe. These are tough calls and online time will tell which of the options taken by these operators will turn to be the smartest move. Risk management is always complicated, even more in the jaws of a recession.

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Author's note: If you want to read more about Banking Risk Management check out this article where I cover the six elements shaping the risk function in the article The Evolution of Bank Risk Management. Find it here.