Outsourcing the Credit Decision

Outsourcing the Credit Decision

By Tim Holland

It seems to me that in our desire to make everything easy we have gone a bit too far and maybe now is the time to rethink and refine the way the financial community does business. Admittedly the mortgage lending difficulties that have been surfacing of late have pushed the problem to the front burner but they are only a symptom of a much larger issue.

Once upon a time the place to obtain a loan was at a bank. It didn=t make much difference what type of loan was involved (mortgage, auto, home improvement, personal, educational) the procedure was pretty much the same: fill out an application and provide the following: a personal financial statement, verification of income, verification of employment, copy of your most recent tax return and personal references. The application along with the supporting documentation was evaluated by a loan officer whose job it was to determine if you were a good credit risk. Also, an important part of the evaluation was the opinion of the loan officer after having discussed the loan with you personally, i.e., his or her gut reaction as to whether you were a good risk regardless of the paperwork.

The primary focus of the loan officer was the protection of the bank and its depositors while making every effort to satisfy the needs of a customer, who is also a depositor - since you wouldn=t make a loan to someone who wasn=t. The loan officer didn=t receive a commission for booking the loan, he received a salary for doing his job: making good loans. The idea of paying a commission was considered by everyone in the industry to be a clear conflict of interest and might induce loan officers to make more marginal loans to increase their income at the expense of the bank. How times have changed.

I=m sure we can probably trace the evolutionary change in the way consumer lending is now done to a consultant who did an elaborate study showing that more than 98% of all consumer loans are repaid and that people are basically very honest so why don=t we make the process easier and make more loans. Having been a banking consultant we make great scapegoats. The truth is that most consultants are brought in to independently validate what someone in management wants to do but needs to show it to be a good idea by an outside expert.

The end result is not a focus on the protection of the bank and its depositors/customers but increasing the value of shareholders= investments. The old priority for management was: the customer, the employee, the shareholder and the new priority is: the shareholder, the customer, the employee. The old way was take care of the customer and the company will be successful which will provide secure employment for staff and steady, long term growth for the shareholders. Employees are now considered Atools,@ Aoperating units of expense@ and it is everyone=s obligation to contribute to the bottom line; everyone is a salesperson.

So how do you protect the financial institution from the conflict of interest of Aloan generators@ receiving commissions? Simple, you don=t let them make the loan decision. But now that everyone in the financial institution in on some type of incentive to generate income, how is that solved? Outsource the decision. Have a computer make the decision. Develop a system where no employee can be held to blame so that they can come up with all sorts of different ways to generate income without being encumbered by responsibility for a bad loan. Besides, we know that people are basically honest and if the computer says one customer is less credit worthy than another just raise that customer=s interest rate and have it all done by an outside computer program. Now we can tell the customer we did everything we could to grant the loan at a low interest rate but that the computer just wouldn=t let us so there=s no point in moving your relationship elsewhere, as everyone is using the same system and no one is responsible.

So as we sit back and watch the foreclosures (that=s called people losing their houses), and the repossessions (that=s called people losing their cars) and the bankruptcies (that=s called people losing pretty much everything else) we can be secure in the knowledge that the financial community has no responsibility for any of it. It=s obvious these people shouldn=t have been able to buy the houses and the cars in the first place and wouldn=t have been have able to if we in the financial community we weren=t forced to out-source the credit decision to that computer so that we could increase the banks income for the shareholders.

Ah yes, the computer made us do it we really didn=t want to but the shareholders forced us into it.

Note:

This opinion/essay is the property of the author. It is offered for use by individuals who are also free to copy and make it available to other individuals as they wish. Anyone wishing to make use of the material for commercial purposes must seek permission of the author, who can be reached at Impressions@Tim-Holland.com. Such permission will not be unreasonably refused.