Credit decisions: The five denying pips
“They pursued only one of the questions,” Holmes said disgustedly, tossing down a thick binder labeled Rudman Report, “and were steered away from others more promising. Ah, well,” he dismissed the question, “it is always a pity when a lender is failing to expand bankability.”
Watson was mortified by the financial shenanigans documented.
“But surely it is up to the individual to qualify,” Watson protested. “It is not the lender’s job to make someone creditworthy.”
“It isn’t?” Holmes said with a touch of asperity. “For some lenders, it is. And it is always profitable to do good business. Yet so many lenders, a herd of limited observance, fail to appreciate how they can expand bankability.”
“People are bankable if they are not unbankable,” he went on after seeing Watson’s look of surprise. “So it may be useful to express the bankability frontier by examining the six credit-based reasons — that is, reasons grounded in a logical decision about credit, as opposed to irrational, prejudiced, or racist reasons — why a lender may deny credit.”
Presbyter Jones was irate that his application was summarily rejected.
“Surely,” said Watson confidently, “lenders decline when they believe they will not be repaid.”
The Man With the Twisted Lip would be unlikely to pass credit screening.
“Indeed so. That is the first of the six reasons. Here” — as he flourished his long ivory fingers as if typing an imaginary keyboard — “are the other five.”
Reasons lenders deny credit
|
Reason |
Lender’s explanation |
What it means for housing finance |
|
1. Inability |
“You couldn’t pay back the loan.” |
The unassailable argument; the grounds for which no solution exists other than changing the income-loan parameters. |
|
2. No credit history |
“I can’t document that you can repay.” |
Arises in cash income, informal income, weak credit scoring. |
|
3. No lending autonomy |
“If I made the loan, my superior (or a regulator) would criticize me.” |
Financial supervisory mechanisms may classify loans as non-performing or questionable even if they are currently paying. Or they may charge such loans a higher risk-based capital allocation (or similar check on lending activity). |
|
4. No income certainty |
“You can pay today, but tomorrow your income could drop.” |
The curse of the informally employed, the micro-entrepreneur, the cash economy. Some forms of financial instrument/ security can hedge around this risk (or reduce loss given default). |
|
5. No macro-market stability |
“A big external event (like higher interest rates) could wipe out not just you but everybody around you.” |
The larger challenge when lending with unstable currencies, inflation, or governments. Abated by generating intra-national rather than international sources of funds. |
|
6. No adequate margin |
“You’ll pay it back but my bank can’t make enough money from the loan.” |
A mixture of (a) pricing challenges, (b) small loan amounts (e.g. high per-loan costs), and (c) opportunity cost (e.g. higher income borrowers are a better risk). Fertile space for innovation, risk-sharing, and public-private partnership. |
The crash in Patagonian rutabaga futures ruined Ogbert Weary’s finances.
“All of this assumes that the governmental environment is stable,” Watson said after studying the chart.
When the minister absconded, the bank was wiped out.
“Correct,” said Holmes. “At the national ecosystemic level, the four rings of housing finance must be in place. You will not with interest that of the six reasons, five of them — the five orange pips, as it were — are improvable, and tend to create new specialist financing houses:
· Credit histories, lending autonomy, and profit-margin barriers encourage the creation of mortgage boutiques that occupy new niches.
· Income uncertainty and macro-market uncertainty invite development of microfinance companies and niche financing products such as variable rates, lower coverage ratios, loans to families rather than individuals, and new forms of non-financial collateral.
Specialist originators can scrub an applicant’s credit history.
“And,” he gestured at the vast tome of papers before the fire, “that is of what some should do much more.”
