Rethinking consumer credit analysis in Nigeria

 

A national economy is a broad composition of individual, business and government spending or investment. In measuring the strength of an economy, governments typically pay close attention to a number of key indicators. Household consumption represents one of those key indicators in the economy. Consumer spending is the result of many factors, including monetary or fiscal policy, inflation, purchasing power and supply of goods. According to the National Bureau of Statistics (NBS), household spending accounted for about 71 per cent of Nigeria’s economy in 2014. Household consumption and the composition of consumer demand also act as useful gauge for the distribution of economic resources.

Economic progress of countries has been associated with the expansion of credit markets alongside all other markets, and while borrowing and repayment are far from problem-free, opportunities to borrow can enhance economic welfare and growth by allowing smoother consumption paths over time. Consumer credit is an important element of any economy, as consumers’ ability to borrow money easily allows a well-managed economy to function more efficiently and stimulates economic growth.

Although, some of the popular discussions around household debt levels has been conducted in a tone of moral disapproval, household borrowing can make as much economic sense as saving when properly deployed. Consumption patterns would be, at best, dismal, if individuals had to consume only their earnings, with no access to assets and liabilities. The life-cycle perspective on household finances by Modigliani and Brumberg (1954) emphasizes savings for old age as the main implication of consumption-smoothing behaviour. But while labour income certainly declines in old age, expectations of rising labour incomes can justify borrowing for young individuals. And the expenditure requirements of durable goods, especially at the time of household formation, usually exceed labour income and accumulated assets in the early stages of an individual’s life. Borrowing in order to finance a more desirable consumption pattern and asset acquisition can be optimal, and in fact desirable, from an economic standpoint.

Lending and borrowing make it possible to redistribute spending from periods in the life cycle in which income is high to periods in which it is low. Earnings are typically hump-shaped: lower both in early life, when an individual is just starting out, and later in life, when people fully or partially withdraw from the labour market, than in prime age. Hence, expectation is for borrowing to be higher for young households, and that households in late middle age should be saving for their retirement. Moreover, households expecting their income to grow more quickly (educated and highly skilled) could borrow relatively more when they are young.

Retail lending in Nigerian is still at its infancy. According to the report by Lafferty, consumer loans at the end of 2012 amounted to $7.29bn, which was about 2.2% of Nigeria’s household consumption for that year, and about 2.5% of the size of consumer credit in South Africa. Curiously, only about 3.8% of the 42 million employed Nigerians as at 2012 were active borrowers from formal financial institutions, while about 93% of Nigerians claimed they could not access formal loans that year.

Traditionally speaking, credit application scores and credit reports define consumers. Good credit signals trustworthy borrowers, while bad or little credit is defined as too high-risk. But these scores and reports do not tell the whole story. A once-reliable borrower might default on a loan due to external factors such as protracted illness or job loss which might put a strain on his finances, causing him to fall behind on credit payments. A traditional credit report doesn’t take these external factors into consideration. There are also millions of people who don’t have enough credit history to secure a line of credit, as is the case of many in Nigeria. These are the “credit invisibles”. If you can’t get credit, how do you build credit? Thus, although credit history provides useful information about borrowers, it isn’t an accurate indicator of creditworthiness on its own.

Innovation is now occurring in the global lending space as financial institutions are now taking a broader approach to assessing creditworthiness. Lenders are increasingly employing alternative and behavioural data to supplement credit reports and compile more informed pictures of borrowers. Alternative and behavioural data pull and analyze information such as education, job history, bank transactions, phone usage, utilities payments and retail activity to find patterns in borrowers’ financial habits, providing powerful indicators of payment and default.

By incorporating behavioural and alternative data into approval and pricing algorithms, banks will be able to cut loss rate and easily identify outliers. This will help red-flag customers who are riskier than their scores suggest and pick out those who are safe bets. People with great credit scores may have risky behavioural patterns and banks may already be lending too much to this set of people without charging them rates commensurate with the risk they truly represent. Conversely, a person with low credit score may pay his bills on time and save consistently, turning out to be a safer borrower.

Technology empowers lenders to make smarter decisions and compile comprehensive data sets on their customers. By accounting for behavioural data over time, banks can identify trends that help them adjust their terms and offerings according to consumer repayment patterns. Credit scores alone can’t help them do that. Alternative data will. If banks in Nigeria are to harness the opportunities in the “credit invisibles” space, alternative and behavioural credit scoring system presents a compelling story, and thankfully, banks are already sitting on a goldmine of data that only need astute mining.

 

  Olugbenga A. Olufeagba