Blood Pressure : Lab Report :: Credit Score: Bank Statement

New-age financial institutions are increasingly financing small enterprises based on cash flows instead of any collateral

Blood Pressure : Lab Report :: Credit Score: Bank Statement

When I applied for a car-loan in 2014, bank statements were unheard in the process of lending because CIBIL, Equifax, CRIF Highmark and Experian reports did the job of predicting risk just fine. And then comes the second half of 2018, there’s an entirely different sentiment among lenders: Reveal your recent banking history or be declined.

Banks generally perceive small-businesses at higher risk for lending and thus incorporate more number of checks in their processes. This is because small businesses typically do not have fixed assets that could be counted as a collateral. Hence new-age NBFCs are shifting the mindset of traditional lenders from collateral based to cash flow based approach in lending to small-businesses.

For all the fanfare surrounding online marketplace consumer lending, access to borrower banking history is oddly absent.

Gauging cash flow is one of the primary activities of underwriting

Banking transactions give the up-to-date bank volume, but it is even more critical with businesses that lack historical data or cannot provide a balance sheet or any other document to show and prove their track record. Lack of credit history and formal financial statements can be overcome thanks to in-depth analysis of bank transaction data.

When underwriters look at a bank statement, they get a better understanding of the cash flow, operational cost and how the owner manages the business. Bank statements tell a great story especially of the monthly momentum, and more importantly a high ratio of deposits to requests for the advance.

Recurring Deposits by Month.*
Largest credits in an individual account

Bankers are in two minds to draw risk insights from statements

“I have a feeling if you seek to crawl someone’s bank account, they’ll go elsewhere because there are many deciding loans based on short-term credit card payment. Even we do it. Making a loan based on crawling bank account and checking deposit balances is rarely a good idea.” — Branch Manager, large retail branch, New Delhi

Not many would be comfortable in sharing bank details for crawling into their account so that lender can develop trust and make a favourable decision to lend. Who wants to mortgage a bank account? There’s another risky side to it where a malicious crawler on lender’s server could crawl & copy your bank login details and pull all your money.

So, how do lenders ascertain if a borrower’s finances are in order before issuing a loan without looking at the bank statement? Any serious borrower should be ready to share banking history of the last 90 days. Note that sharing a pdf statement of your bank account is different than crawling where in you login to your bank account on a third party website and let the program scrape your months of bank data.

It further led us to interview a credit risk analyst who oversees a department of people that manually assesses credit card applicants at one of the India’s fastest growing retail bank. We found that there is no algorithmic approval process in assessing consumer credit risk. In another instance, we found that a home loan department of one of India’s largest retail bank, humans underwrite each application, conduct phone interviews with the prospective borrowers, and request additional documents if required.

New-age institutions do not follow the ages-old traditional bankers mindset!

In another interview with the manager of operations at India’s largest P2P lending company, he explained that requesting bank statements is a regular part of the job. He further added,

“We require proof of cash flows for every loan request. Along with proof of address, it’s the main thing we ask for.”

The manager shared that he believes there is a robust correlation between credit report and bank statements. Proper credit score usually shows a healthy banking situation, he explained. Healthy bank statement is a validation of credit score but not vice versa.

The credit report might show as expected, a moderate income level, and job title, but the borrower could have negative Rs.50,000 in the bank and be living off overdraft protection on day 1 and a lender would never know it.

Small business credit behaves like consumer credit

Owner’s bank account activity is one of the key determinants of small business loan default.

A critical aspect of consumer lending is determining the appropriate amount of a payment to collect so that an account is not overdrawn. Secondly, a borrower’s credit report does reflect the status and payment history of running loans but it is at least a month old. A recent bank statement will always show the recent behaviour of loan repayment and status of recurring bill payments.

Summary of all running loans and it most recent payment behaviour
Define a low balance to see occurrences of low balance

Isn’t it safe to assume that there is a positive correlation in bank statements to the rate of returns incurred during the process of underwriting?

Also, while it’s true that bank data can’t make predictions perfectly on its own, nobody in small-business lending or merchant cash advance would consider an approval without it.

Every business is unique and money moves fast through these businesses, hence more variables come into play than just timely payments of credit cards, cars, and mortgages as found in the consumer world.

A credit score along with other information presented in a credit report provides a detailed, historical snapshot of a client’s creditworthiness in consumer lending, while these are great complementary tools to use in the underwriting process, it is now quite evident that banking data tells a story of its own which is essential in assessing the risk of a B2B transaction.

A consumer has a predictable stream of income because of monthly salary and so that information along with a credit report might be enough for a consumer lender, but business revenue is less predictable and can vary practically day-to-day. A credit score alone is not enough to judge if a business is good for lending. The story is in the bank statements of the business and its owner.

A time series analysis of the closing balance identifies patterns and unusual activity.

Note how many times the graph touches the horizontal bar which signifies zero or lesser amount in the bank at that point of time. Toggle with the bar.

The credit score is like reading a person’s blood pressure. It indicates there might be an issue, but until the lab work is analysed, we won’t know what that issue is. Analysing a bank statement is that lab work, and it can tell you more about the risks behind the scenes than a credit score alone can.

*We’ve intentionally changed the identity of source & destination of transactions

Thanks to Samkit Jain and droan for reviewing the draft.

This post was originally published on Medium by Kumar Tanmay.