Collection of delinquent debt is one of the largest untapped opportunities for Indian banks as they face continued economic headwinds and more loan defaults. The prize is huge—and within reach. Realistic improvements in collection practices could lift the banking sector’s profits by 10%, and by as much as 15% for the most aggressive lenders.
The challenge is stiff. Solving the collections problem will require banks to better mobilize data and attain operational excellence. Bank lending was too permissive during the economic boom between 2004 and 2008, when the global financial system imploded. Since then, non-performing assets of the top 10 banks in India jumped to almost Rs20,000 crore in the fiscal ended March 2009, a 23% increase in just one year, as their profit growth slowed from 40% in 2007-2008 to 29% the following year.
Many banks are now taking tough steps to reverse the growth in delinquent loans. Several leading lenders have stopped unsecured lending completely and tightened overall lending norms, including restricting credit limits. But none of these actions will help them avoid the inevitable crest of losses that shows up between 18 and 24 months after accounts are brought on the books.
The Indian challenge
Collecting loans in India is more difficult than in developed markets. Lack of fixed-line telephones and an ineffective credit bureau make it difficult to contact debtors. Lenders do not have access to a centralized system for tracking delinquent borrowers as they change addresses and mobile phone numbers to avoid paying their dues.
Then there are the legal costs. As the size of loans in India is small—they can be for as low as Rs5,000—pursuing collections through India’s slow legal system can prove prohibitively expensive. When banks do approach the courts, they can recover only 50-60% of defaulted loans. Close to half the cases are settled through a compromise—outcomes that could have been anyway achieved outside the judicial system at less cost. Therefore, Indian banks often find that they have little alternative other than to rely on field operations.
Independent debt-collection agencies (DCAs), working for banks, directly contact between 20% and 50% of potential defaulters in India. In the UK, by contrast, less than 5% of delinquent borrowers are contacted directly by field agents. But agencies are expensive in India, typically taking a 10% cut of what they recover on a loan that is between 90 and 120 days in default. For collecting on a loan that is late by 180 days or more, they take a commission of at least 30%. Reliance on collection agencies can also extract a high price in terms of bad publicity. The agents are often poorly trained and use crude tactics such as endless phone calls and hiring local toughs to harass defaulters.
Clearly, Indian banks need to do a better job collecting bad debts, whether by strengthening in-house capabilities or by making better use of external agencies. To do so, they need to master the fundamentals of collections, as the Indian market lacks sophisticated credit-rating agencies; has a slow legal system; and is home to many unreliable collection agencies. Our experience working with banks around the world shows that the following three steps can lift collection rates, reduce risks, and boost profits.
• Identify what’s collectible now: Banks need to act swiftly to gather data on customers and their credit histories in order to home in on the most readily collectible debt. Then, they should segment these receivables according to such criteria as a customer’s value, payment history, credit worthiness, as well as by the value and age of the debt outstanding. The best practice is to focus on debts that can be targeted for immediate collection and tag them for separate treatment. The aim is to put on the front burner what will bring in cash the quickest.
Each segment requires a detailed treatment plan that may involve calling defaulters, sending letters, and using external agencies. For instance, bank call-centre staff can adjust their approach to different segments of customers. They can take a more consultative and less intrusive approach to customers who have never missed a payment but suddenly go 30, 60 or 90 days behind. This type of customer typically has lost a job or suffered a major financial setback. With this group, be willing to accept partial debt repayment as a final settlement and quickly close the account. However, for a customer who has a pattern of missed payments and is likely to become delinquent again, a different approach is needed. Here, more frequent calls and letters make sense, but accepting partial settlement should be avoided as it results in bigger write-offs of unpaid balances.
• Turbocharge implementation: Banks need to ensure that they effectively implement their debt-collection plans for each segment to boost recoveries. The impact will be immediate and build over time. They can begin by improving their own capabilities, ramping up internal treatments by greater use of in-house call centres. This involves understanding the economic impact of every action and experimenting to determine the most effective techniques to apply.?Once the right ones are identified, agents need to be trained in skills like negotiation and debt counselling to achieve results.
Externally, banks can strengthen the performance of debt-collection agencies by bringing management discipline to bear—using tests to identify the most economically productive approaches and tracking to optimize performance. Critically, banks need to monitor agencies’ recoveries and the techniques they use. They should also concentrate their external debt collection with just a few high-performing agencies rather than continuing to farm out the job to many small contractors with little effective control. One area of potential collective gain is the sharing of information about DCAs across banks, which will allow all lenders to exercise greater control over these agencies. This “DCA rating agency” would prevent a number of unsavoury incidents involving external agencies.
• Track, learn and evolve: At present, no Indian bank has cracked the collection problem. Globally, banks that run successful collections programmes recognize that best practices evolve. They carefully monitor what’s working, develop new insights, and test new approaches. They do this, first, by regularly revisiting their segmentation strategy and refreshing it. They also closely monitor their debt-collection contractors. They weed out the poor performers and work with the best agencies to refine best practices and reward them with more work. Finally, they fine-tune their credit screening procedures, adjust terms and conditions to better reflect borrowers’ delinquency potential as business conditions change, and respond more quickly to changes in repayment behaviour. Taking pre-emptive measures to spot delinquencies before they go bad ultimately is the most effective way to keep bad loans from eroding good profits. Smart lenders recognize that the best debts are ones that don’t require special collection efforts in the first place.
David Mountain is a partner in the Mumbai office of Bain & Co., where he leads the firm’s financial services practice in India. Sandeep Nayak is a manager in the financial services practice in the firm’s New Delhi office.
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