NBFC

How Technology Improves Credit Risk Underwriting Process for NBFCs

The NBFC sector has witnessed a drastic shift in the lending landscape post-digitalisation. This sector has incorporated automation in its various operations, such as customer acquisition, onboarding, and verification. However, it is yet to fully embed the same in the credit underwriting process as many NBFCs are still dependent on manual assessment of the various aspects of this process, causing delays in the loan approval and enhanced risk of defaults and NPAs.

The article discusses how technology improves the credit risk underwriting process for NBFCs and facilitates a faster and streamlined lending approach.

What is Credit Risk Underwriting?

Credit risk underwriting can be defined as the assessment of the borrower’s personal, financial or business information to ascertain the creditworthiness and possibility of failure in the repayment of a loan taken by the borrower.The process involves the verification of KYC^[1] documents along with a detailed assessment of the applicant’s credit report on well-established benchmarks by the NBFC.

What is the procedure of Credit Risk Underwriting?

The procedure of credit Risk underwriting is consolidated through 5 Cs, which are Character, Capacity,  Capital, Collateral and Condition.

Character

Character signifies the borrower’s credit history, which starts accumulating once the borrower begins taking credit cards or loans/ the banks report the account history on the borrower. The banks further send this information to the credit bureaus to create credit reports which some designated companies use to calculate the borrower’s credit score or the CIBIL score.

The NBFCs consider this credit score and reports to analyse certain key information such as foreclosures, late payments and bankruptcies. The NBFCs often set a minimum credit score requirement for the grant of a loan. The credit score and the credit risks are inversely proportional, i.e. a higher credit score signifies a lower credit risk.

Capacity

The second C in the credit risk underwriting denotes the Capacity, which can be described as the borrower’s ability to repay the loan. The NBFCs determine the capacity of the borrower by calculating the debt-to-income ratio.

The debt-to-income ratio is the percentage of the gross monthly income utilised to pay debts by the borrower. Higher DTI signifies a lower credit risk which is a crucial determinant for the approval of the loan application of the borrower.

Capital

Capital includes the assets, savings and investments that the borrower is willing to utilise for the loan. The capital can be accessed through the balance sheet. The main objective of the NBFCs to consider this aspect is that investing in personal capital reduces the chances of default by the borrower. It further signifies the willingness of the borrower to take a personal risk for the sake of his business.

Collateral

Collateral refers to the asset pledged for the repayment of the loan by the borrower. The NBFCs evaluate the personal as well as the business assets of guarantors along with the borrowers as the borrowers act as an alternate source for repayment of the loan. However, the type of collateral shall depend on the type of loan required by the borrower.

Conditions

The NBFCs identify the condition of the industry, business and economy. The financial institutions/lenders need to verify the requirements of the individual/ entity. The verification involves ascertaining whether the condition will continue, improve, or deteriorate. In addition, the lender would also ascertain whether the loan proceeds will be used, such as working capital, renovations, additional equipment, etc.

What is the Need for Technology in the Credit Risk Underwriting Process

The NBFCs felt the need to adopt the automated credit Risk underwriting process for the following reasons.

Expectations of the borrowers 

 The traditional banks used to depend upon physical distribution methods and the manual calculation of the credit scores for ascertaining the credit worthiness of the borrowers, which has been quite challenging for meeting the changing customer needs for speed and simplicity. The rising demands for fast online credit approvals are rapidly growing, which has compelled the NBFCs to revamp the Credit risk underwriting process.

Reduced back and forth client interactions

The current process requires emailing, scanning, and faxing financial information and supporting documentation; This can be a tedious and back-and-forth process. Customer-facing interactive portals can easily enable the digital capture of such information. One such example is the video KYC launched by the Reserve Bank of India in the year 2020

Unnecessary manual work: 

 The traditional credit risk underwriting process involves a considerable amount of unnecessary manual data entry. It becomes essential for the NBFCs to leverage a portal that connects to the borrower’s financial accounting package, that must have an inbuilt feature of reading tax forms digitally.

Delays in decisions

The manual generation of the financial spread is a time-consuming process that can be reduced by applying innovative machine-learning technology in the credit risk underwriting process.

 Higher Risks

 The primary issue faced by the NBFCs during the traditional credit risk underwriting process is the ascertainment of risks in the loan applications of the borrower. The agents must check the applications thoroughly to mark any errors that can cause credit risk in the future, which can be pretty troublesome for NBFC officials.

Pressure on cost and returns. 

The new participants in the market are challenging incumbents’ revenues and cost models. The traditional banking operations, legacy IT systems and branch networks can be tiresome Fintech companies operate at much lower cost-to-income ratios. This is approximately 40 per cent lower, according to a report by McKinsey.

How Technology Improves Credit Risk Underwriting Process for NBFCs 

Technology ca n improve Credit Risk Underwriting in the following ways

 Reduced Turnaround Time (TAT) –  

Consumers need a fast and efficient Personal loan process in today’s time. Earlier, the lenders had to undertake manual verification processes, usually taking several working days to finish. As fintech firms have developed innovative technology, digital verification can be done digitally through Video KYC, eKYC, eSigning, etc. Thereby reducing the turnaround time by almost 10 times.

Better Decision Making

The credit score is considered one of the most crucial aspects of credit risk underwriting or assessing the individual’s creditworthiness. The automated system works. The decision is based on the in-house proprietary algorithms to evaluate an applicant.

These algorithms help assess multiple elements of the borrower’s credit profile, like CIBIL Score FOIR, loans taken, etc. Credit managers use Social score algorithms to further strengthen their decision accuracy. The use of technology helps them get deeper insights into the applicant’s spending behaviour, lifestyle, employment stability, etc., resulting in faster yet wiser decision-making.

Enhanced scalability

Earlier, the NBFCs used to carry out the verification process by sending a designated agent to the geographical location of the borrower for verification before lending. Now technology has enabled the lenders to verify the consumers’ profiles irrespective of their geographical locations by using tools like geo-tagging, eKYC and other online verification processes, thus helping them unlock the untapped credit market and scale.

Increased Inclusion

 The traditional lending system solely focussed on the credit score for deciding upon the loan application, which was a problem for the borrower who applied as first-time borrowers, which led to the rejection of loan applications of such borrowers. However, digital lenders do not just consider credit scores but various other factors such as income stability and job stability. Thus, with the entrance of digital lenders, first-time borrowers enjoy easy access to credit when they need it the most.

Conclusion

To implement a sustainable business model in this cyber revolution, it is of paramount importance that all the processes and workflow are streamlined according to the changing dynamics of the market. The traditional credit risk underwriting process causes delays in credit estimation, loan approval and releases. The time and the cost of processing each loan application can be reduced drastically by streamlining the credit risk underwriting process to replace legacy methods. Hence, automation can help deliver immense improvement. 

Read our Article: Is Alternative Credit Scoring Method a Smart Move In Indian Fin-Tech Business?