Balance Growth Strategies
Building Revolving Balances
Typically, a lender assumes a fixed amount of risk when a revolving credit limit is offered to a customer and in return for that risk they expect to generate revenue from any interest bearing balances that arise. Since an account that goes bad is likely to do so for the full limit, it is important to get and keep the balances of ‘good’ accounts as high as possible.
There are two basic ways to ‘get’ and ‘keep’ balances high: balances can be grown through spend campaigns but typically the best results come from campaigns encouraging large, once-off transactions most often through an inward transfer of an existing balance held with a different lender; balances can be maintained by slowing down the rate at which they are paid down by reducing the minimum repayment amount and/ or by encouraging more customers to pay only that minimum..
Before determining which approach will likely work best in each situation it is important to understand some key characteristics of the customers involved.
Customers can usually be divided into two groups along similar lines: one group uses their card as a convenient means of transacting and pays the full balance each month and are thus called ‘transactors’; the other group, called ‘revolvers’, uses their card as a convenient form of credit, making larger but less frequent purchases and then paying the resulting balance down in monthly instalments.
To generate more revenue from transactors one of two things need to happen: either spend should be increased to boost the level of commission earned (the charge card model) or – though ideally and – some level of revolving balance should be encouraged. It is usually difficult to change a customer from a transactor to a full revolver and so it is more realistic to aim to add a revolving balance portion while the standard monthly spend continues to be paid off as before. This can be achieved by enabling two types of balances to co-exist within one product – one that revolves and one that clears monthly. When I worked in the credit card industry in South Africa we used to call the revolving portion of a card balance the ‘budget facility’ and it managed revolving balances on a transaction-by-transaction basis with client-selected terms for each transaction of between 6 months and 24 months, though it can take on any number of similar forms.
The key is to allow these customers to continue using their card as a convenient form of payment for day-to-day transactions while simultaneously encouraging them to also view it is a convenient source of credit for larger, infrequent purchases.
These larger, infrequent purchases can have occurred in the past in which case a balance transfer will bring them onto the lender’s book or can occur in the future in which case they can be encouraged using traditional marketing campaigns or specific campaigns for high value purchases in-conjunction with retail partners. The first form of balance transfer theoretically leaves risk unchanged as it simply moves a debt from one lender to another, however, since it likely frees-up exposure again with the original lender some caution should still be applied. That said, the risk is certainly lower on average with balance transfers than it is with revolvers.
Revolvers will tend to grow their balances over time as new spend is added faster than old balances are paid down. To increase the rate at which these balances increase it is possible to offer balance transfers as discussed above or to slow down the rate of pay-down. This would be achieved by reducing the minimum payment ratio – from 10% of the balance outstanding to 5% for example – or by offering payment holidays.
Revolvers will always be good candidates for limit increases as they are most likely to use the new exposure productively. Though of course risk should always be a factor when granting higher limits. Revolvers on average are riskier than transactors by some margin. In a recent project 95% of accounts with high utilisation got there by revolving, but revolving accounts were also six times more likely to be ‘high risk’.
In particular, risk is high where a significant portion of the revolving balance is made-up of small value, day-to-day transactions. As soon as daily expenses are being paid-off over several months there is a high risk of debt ballooning to unaffordable levels. This is easiest to spot where balances are added on a transaction-by-transaction basis but can also be detected, using ratios, where transactions are first consolidated and then paid down.
Building Fixed Term Balances
Fixed term loans present fewer opportunities for balance management but those that do exist are based on the same simple principles. Balances can be increased either by offering larger loans at take-up; by slowing down the rate at which balances decrease or by increasing the balance periodically during the life of the loan.
Many lenders use some multiple of income – often one reflecting risk – to set the size of a loan they are willing to offer a customer. But many of those lenders don’t use the same tool to create a shadow limit when the request is customer-initiated. Of course there are certain markets were regulations forbid up-selling but where it is possible to offer a new amount and where the customer amount is within the amount the lender would have offered, it makes sense to offer a higher amount. (The over-riding rule though should always be that the customer knows best and so even if the possible loan amount is much higher than the requested amount, some multiple of the requested amount – say 20% – should always be used as a floating maximum with the lower of the two being offered as an up-sell.)
The more conservative approach, on the other hand, is to keep original loan sizes low and to instead aim to extend the life of the loan once taken-up.
The simplest way to do this is to extend the term of the loan by offering payment holidays. Under such a campaign the bank would offer its good payers the option to not make a payment in one particular month and instead to add that repayment to the end of the term, effectively pushing the loan’s termination date out by just over a month for every month skipped. The higher the interest rate charged and/ or the shorter the original term of the loan, the larger the extension will be relative to the number of months skipped. Payment holidays can either be customer initiated or fixed around certain keys dates – major holidays, etc. Payment holidays, however, only have a limited impact – seldom extending the total term of a loan by more than 10%.
A bigger impact can be achieved by top-up campaigns. The nature of a loan with compound interest is such that the outstanding balance decreases exponentially over time; slowly at first and very quickly at the end (see this article on annuity curves for more). This means that the lender earns most of their profit in the first half of a loan and much less in the second half. To keep the revenue-earning balances high, top-ups should be offered to good customers as soon as this rapid decrease has set in.
The nature of the original loan will also play a role here. Loans secured against depreciating assets – such as vehicle loans – are less suited to top-ups since the realisable value of the security at the eventual end of the loan may be very low.
Once a lender has decided to explore the option of a top-up campaign, there are four considerations: the size, the frequency, the pricing and the legal implications of the offer.
Top-ups can be offered back to the original loan amount or to a new, higher amount. Limits can also be pre-approved or simply marketed as an invitation-to-apply. The quality of behavioural scores – or the data needed to create them – will dictate which one is the better option in each case.
The timing of the top-up offers will vary based on the term and interest rate of the original loan as well as the nature of the product. The top-up should only be offered when the new amount offered is meaningful. Three years into a twenty year home loan the principal is almost unchanged and so a top-up – at least one back to the original loan amount – is unlikely to be of a useful size. Three years into a five year unsecured personal loan the principal will be meaningfully reduced and so a top-up might be well-received.
Where a new price is being offered in conjunction with a top-up, the lender needs to decide whether they want to offer the new price only to the new amount paid out or to the whole loan. Assume a customer who originally borrowed €3 000 at 10% has shown good payment behaviour and so now, with their current balance standing at €1 500, has been offered a top-up of €1 500 at a discounted rate of 9%. The lender must choose whether that offer will mean the current balance of €1 500 continues at 10% while a new balance of €1 500 is created and charged at 9% or whether one large, new loan of €3 000 at 9% is created and simultaneously used to pay-off the old loan immediately. This decision is a commercial one – unless legislatively enforced – which must be understood to avoid unexpected impacts.
The final consideration is also one needed to avoid unintended consequences. Offering a top-up loan will extend the term of the loan which may allow certain conditions of the original loan contract to become invalid. This is particularly true with matters relating to security and the right to collect outstanding balances. Where needed, therefore, new contracts should be included as a step in the top-up process.
