Though the Credit Card Accountability Responsibility and Disclosure Act of 2010 is not a year old, in June lawmakers passed even more card restrictions, capping limits on late fees. The changes have left banks seeking new ways to boost profitability. But as the pool of creditworthy candidates shrinks, lenders must be strategic in their approaches to the marketplace, making the need for analytic insights more critical than ever. Here are five strategies lenders can utilize to remain profitable while handling the new regulations.
1. Analyze the customer before offering card terms. Under the CARD Act, issuers won't have the same freedom to adjust APRs on existing credit cards. This means that it will be critical to get the pricing right at the time of an account origination, as it will be difficult to change after the fact. To do this -- and save money -- issuers must use precise customer segmentation and microsegmentation methods to identify the best customers the first time around and optimize the initial line and price combination for best results.
These steps should be baked into the overall marketing process. A speaker at the recent FICO World conference observed: "Banks can't continue to put together offers by making sequential, unrelated decisions about APR, credit line, and other terms and conditions. To make profitable offers in the new environment, they need to take multiple factors into consideration simultaneously and make a unified, optimized decision."
2. Make targeted credit line increases. Issuers have been hesitant to make changes in the past few quarters, and few are increasing credit lines that would incur additional risk. This leaves a considerable amount of money on the table that lenders could earn if they analyzed their customers' true ability to pay.
Unfortunately, the predominant response to the CARD requirement has been for issuers to assess a consumer's ability by combining income estimation with some sort of debt-to-income ratio. Many lenders use income estimator tools as a shortcut for a true ability-to-pay model, but historically income has not been a good predictor of risk. In this situation, it is essential that a lender look at pure capacity to remain profitable and adhere to regulatory compliance.
3. Price based on risk. Lenders must take a more precise approach to determining APR adjustments for late payers, one that will maximize repayment and maintain customer relationships while avoiding write-offs. Under optimization, lenders can find this point to further cover their risk as an issuer without creating a charge-off situation. As another FICO World session panelist said: "It doesn't make sense for us to charge a huge APR that will cause 80 percent of balances to go to write-off while penalizing those customers who find a way to pay us back."
4. Authorize selectively. Due to penalty fees, over-limit customers traditionally have been profitable. But as the market continues to evolve under the CARD Act, issuers may be forced to figure out which non-opt-in accounts will remain profitable. To revamp these policies, issuers must understand the variability of customer behavior with action-effect decision modeling and alternative credit policy simulation, segmenting the population to find those customers who will prove to be the most profitable. The best way to do that is by using additional analytics, such as credit capacity scoring, along with action-effect decision modeling and optimization.
5. Factor in macroeconomics. During a recession, and when working under new regulations, issuers must adjust policies based on changing customer behavior and an understanding of how economics will affect customer risk. New analytic methods can forecast how macroeconomic conditions are likely to change the repayment behavior of customers and the risk at different credit score tiers, guiding decision strategies based on how default rates will change under various economic forecasts.
If an issuer's goal is only to comply with ability-to-pay requirements, then integrating an income estimation with a credit score may be adequate. But if the goal is to make more profitable and compliant decisions, issuers need additional analytic insight into the variability of consumer behavior, especially as that behavior changes in the new environment.
Lynda Woodward is FICO's principal scientist.