Jon Hudson argues that motor finance providers need to look
closely at their risk management procedures
The credit crunch has turned what was already a complex
financial market into a vastly more competitive and challenging
arena. The country is seeing higher levels of loan defaults and
home repossessions. This has sparked greater fears among lenders
about exposure to bad debts and, as a result, lenders are turning
more people away.
No other sector understands the importance of risk management
more than the financial sector, but even the best risk management
strategies need constant review and amending to ensure that they
are performing optimally. Those lenders that are managing to ride
the credit crunch are the ones that are constantly reviewing and
challenging existing strategies.
The former CEO of General Electric, Jack Welch, once said:
“Change or die.” Unfortunately the situation is such that there are
still too many companies that have yet to recognise the immense
value and competitive edge to be gained from controlled
This can be seen in the fact that during the first six months of
this year, the number of banking and financial services companies
that went bust rose by 58 per cent compared to the same period last
year. Of the 34 sectors, this is the second biggest increase in
business failures (the property sector, quite naturally, saw the
biggest increase – up 81 per cent). This is a worrying figure for a
sector that invests so much in risk management.
Most companies when designing or developing strategies tend to
replicate existing ones based on previous success. The mindset is
that if it has worked well in the past, then it should continue to
do so in the future. However, the world is constantly changing.
Populations evolve and economic conditions shift over time. Under
certain circumstances, such as the current one which is being
labelled by experts as the worst in over 60 years, they shift
particularly quickly. We are now in a period of immense change and
the ‘champion challenger’ philosophy has never been more
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The ‘champion challenger’ is a widely used term in the credit
industry to describe the way in which the existing strategy (the
champion) is routinely tested against an alternative, untried
approach (the challenger), ideally in a live but always in a
controlled environment to avoid excessive financial loss if the
alternative strategy fails. It enables companies to test the
benefits of a new strategy against an existing one in a low risk
way. In practice, the test is undertaken using a small
statistically valid subset of applications or the account base (the
technique works equally well for both new business strategies and
existing customer ones) and closely monitored. Should it not be
performing as anticipated, the test can be quickly curtailed.
If the challenger strategy should prove to be outperforming the
current or champion strategy, the challenger strategy is then
allocated a much larger proportion of the portfolio. Change,
therefore, can be controlled and the associated risks minimised. If
it proves completely successful, and there are many measures of
this depending on the strategy objectives, it can be rolled out to
become the champion strategy.
It is crucial that the successful new strategy be deployed
quickly to gain the business benefits, whilst simultaneously
implementing the next challenger in line. This is necessary,
especially in the current environment where a strategy that works
one day may not necessarily work as efficiently the next.
Unfortunately, too many lenders have been hit by higher bad
debt, yet are still approaching the situation the way they have
always done. For example, in the collections environment, debt has
increased significantly and those lenders that were used to dealing
with, for example, just 10 per cent of their business as
delinquent, are now seeing this figure doubled. Instead of
reviewing the problem objectively and testing new ways to resolve
it, the instinct is to recruit more staff to handle the extra
workload. However, recruitment takes time which inevitably slows
down the reaction time. The problem worsens and costs increase.
Dealing with the unknown tends to inhibit companies from trying
out the more radical ideas that often offer large potential
benefits, but also have larger potential risk. Many companies are
unwilling to implement any kind of testing or change unless there
is great pressure to so. The harsh reality is that these are the
companies that will stagnate and struggle in this
In the motor finance industry, while some providers have
embraced the concept, many are still relying on the old ‘tried and
tested’ strategies they have always used. It can be argued that in
the current environment there may be a greater need for motor
finance providers to take on the ‘champion challenger’ philosophy.
While the credit crunch has limited the amount consumers can borrow
from many financial institutions, car credit still appears to be
available and is continuing to assist many who are feeling the
strain of the credit crunch. This is likely to fuel greater
competition as well as create greater risk.
The motor finance sector should adopt the mentality that
there is always room for improvement. Change takes place whether we
like it or not. By adopting the ‘champion challenger’ philosophy
and implementing it across an entire portfolio, a company can adapt
and change in a controlled manner as quickly as its environment and
maintain a competitive edge at all times.
The author is head of financial services within Experian’s
Decision Analytics business