Non-performing loans (NPLs) continue to put pressure on European banks, playing a critical role in profitability and determining the overall financial health of the banking infrastructure.
Banks with a high volume of NPLs often experience a reduction in net interest income, an increase in impairment costs and additional capital requirement for high-risk weighted assets.
Furthermore, NPLs require additional management time and servicing costs to resolve the problem.
Despite there being a decline in NPL ratios over the past couple of years, these bad loans remain dangerously high in several countries, including Greece (43%), Cyprus (22%), Portugal (11%) and Italy (9.5%).
Overall, the ratio of gross NPLs in Europe sits at 3.8% and the total stock on the balance sheets is around €580 billion. While this is a considerable drop from the 8% ratio and €1 trillion figures recorded 5 years ago, Europe is still quite a ways behind other major advanced economies. To put this into context, the NPL ratio in the United States and Japan is just 1.5% and 1.1% respectively.
The question is, what are the key challenges that are impacting the way European banks tackle the NPL crisis? In this article, we highlight some of these key issues and explore possible resolutions.
What are the 3 key challenges in addressing NPLs?
Banks seem to be lagging with their approach towards collections by relying on phone calls and letters. In today’s world, digital-savvy Millennials and Generation Z don’t have the time to pick up their phone during working hours or sit in long call queues after receiving a letter. They demand the convenience of self-service.
McKinsey’s research on how customers experience delinquency contact highlighted the banking industry’s disregard of the channels that statistically lead to the best customer outcomes. In fact, a staggering 32% of total respondents who hold accounts that are 30+ days past due revealed that the channel of last-contact used by their banks was phone. In contrast, only a small percentage stated highly effective digital channels, such as email (17%), text messaging (7%) and mobile push notifications (6%).
To make matters worse, these outdated operations require too many manual processes which are also expensive for the banks. These methods also lack in personalisation and create several ineffective touchpoints which perpetuate an unwelcoming, hands-off approach to customer experience.
A better approach to operations is to use analytics and machine learning to understand behaviours, artificial intelligence to segment customers and to assign the handling of NPLs to the right personnel.
A lack of flexible technology solutions
Despite there being an abundance of options presented through technology, one of the biggest challenges in addressing NPLs is the lack of flexibility in current banking collections strategies.
For example, if a customer is suffering from financial hardship and their account falls into arrears, current banking collection processes simply don’t have the capability to pivot. When banks don’t offer a reactive solution, customers may start to ignore messages.
Most technological solutions used by banks to address non-performing loans focus on automating the collections process. This is fundamentally bank-centric and not customer-centric. These automated processes cannot recognise patterns of customer behaviour and are insensitive to their need for personalisation.
The collections operating model needs to be flexible enough to allow banks to segment different audiences and change their approach accordingly. For example, a purely digital approach should be prioritised over phone calls for low-risk customers. Whereas, for higher-risk customers, collectors can use the data and information collected to identify the needs of the customer and create a tailored solution before making contact.
Developing an adaptable system gives banks the room to negotiate effectively and achieve better outcomes, or allocate specific teams to take ownership of certain scenarios. For instance, a bank can set-up a collections team who focus on developing solutions for customers who have just lost their job or are only experiencing temporary payment issues.
Prioritising short-term results
Another reason why NPL ratios remain high in the banking industry is that banks often focus on the short-term results, instead of seeing the long-term value in acquiring more qualified customers.
Consumerism and inflation are creating a reliance on loans. It’s the duty of a responsible lender to carry out proper credit checks and manage the accounts accordingly.
Banks must develop internal credit risk assessment models that analyse the financial and other data of loan applicants, placing a greater emphasis on correctly assessing the default probability.
The credit policies in many European banks are centred around making more profit from interest loans with no thought towards retention.
According to Invesp, 44% of organisations place a greater emphasis on customer acquisition versus 18% who focus on retention. Yet, it costs five times as much to acquire new customers, than to keep an existing one. This is creating a system in which European banks are piling up new bad loans on top of the old ones, thus maximising acquisition but worsening the NPL balance sheet.
This worrying trend is not only causing issues in the collections process, but it’s forcing banks to spend more money on marketing and sales to acquire new customers.
Resolving the burden of non-performing loans
“It seems that inflows of new NPLs are still on the high side – not least when you consider where we are in the business cycle. It also seems that some banks with high NPLs are still reporting increasing default rates. We find this somewhat worrying, and we urge banks to stem this inflow by rethinking their underwriting standards and engaging with distressed debtors.”
Andrea Enria – Chair of the Supervisory Board of the ECB
With increasing importance given to customer experience, Collections practices have changed significantly over the past decade. Using the right tone and the right channel are imperative in effectively helping those experiencing financial difficulty.
The banking industry must ensure they are better equipped to deal with customers, especially those in the collections cycle for a long time. Using advanced technology and harnessing the power of artificial intelligence are more aligned with 21st-century consumer preferences.
While most banks have deployed some sort of proprietary software, bought SaaS software, or have collaborated with a third-party collection agency, very few have started leveraging the technological and analytical opportunities available. As mentioned earlier, there are too many manual processes and not enough efficient application of analytics, machine learning, artificial intelligence and automation to better handle the management of NPLs.
A technology-led collections platform which utilises these elements is a long-term solution that will enable banks to:
- Establish customer preference – i.e. what channel to use to communicate and when to contact them.
- Develop nudges – i.e. introduce payment plans and incentives, as well as use certain language tailored to suit a customer’s particular circumstances.
- Enhance customer experience – i.e. using data, banks can understand how to communicate and include touchpoints at every stage, including before they enter the collections cycle. Offering self-service capabilities also gives customers the freedom to act when they can and on their own terms.
Personalisation is a vital element in the modern world. As we discussed in our article on ‘Essential KPIs’, using common collections metrics and KPIs, such as Right Party Contacts (RPC) and Profit per Account (PPA) are no longer the only way of measuring NPLs. Nowadays, it’s essential to understand the performance of:
- Email delivery rates/bounce rates
- Email open rates
- Click-through rates
- Traffic by source or channel
- Landing page views
- Reaction times
These digital marketing metrics enable banks to address the root of the problem with their collection processes and create a personalised solution.
Using technology-led collections software to lead this kind of granular approach will also give banks more time to strengthen the loan underwriting processes and conduct more rigorous credit risk assessments at the start of the lending process.
Deeper analytics and insights will allow banks to develop more detailed client profiling to assess risk, optimise legal services, to reduce expenses and to add more suitable touchpoints to enrich the customer journey.
Those banks which embrace the evolution of the global credit environment and open themselves up to the possibilities of technology in collections now have every chance of overcoming the three key challenges in addressing NPLs.
Learn more about the future of banking collections
If you’re interested in hearing more about how technology-led, self-service collections software can improve NPL ratios and revolutionise customer experience, download our new Future of Collections in Banking white paper.
Inside, we take an in-depth look at the current state of collections, the opportunities presented to banks and how to turn these into action, plus the future outlook of collections processes.