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Looking Towards The Future – A high risk is not necessarily a bad risk

Author: Wayne Pearce, Business Solutions Manager, Neural Technologies

Rapid change and increases in competition are driving the financial market. Over the last few years, the market has undergone significant changes due to the introduction of the Internet, growth of e-commerce and the effects of the mortgage market deregulation.

These changes are resulting in the diversification of the financial services market. For example offering services such as mortgages and loans on-line, fighting for customers through offering the lowest interest rates on credit cards and highest interest rates on accounts. Due to the continual increase in competition, the financial services are realising that there is significant scope for profitable business in the sub-prime lending arena and that high risk is not necessarily a bad risk.

The sub-prime market is becoming an ever more significant part of the financial industry’s future, estimated to be worth several billion pounds per year and forecast to grow significantly.

Sub-prime means different things to different lenders. To most lenders, sub-prime means an applicant from outside of the standard “core” business with a perceived higher level of risk. For some companies, individuals who have moved jobs more than three times in the last two years will be sub-prime, while for many mortgage companies it may be the self-employed. All of these have one area of similarity – they could be excellent risks. The person moving jobs could be a high earning company director and the self-employed person may be a highly paid and successful consultant. It is apparent from the above examples that some sub-prime risks may in fact be highly profitable, even though they fail a company’s rigid rules for granting credit. These examples highlight the principle that not all sub-prime risks are bad risks.

However, these are not the only risks that can be profitable, high risk customers such as those with County Court Judgements or with past mortgage arrears can also generate bottom-line improvements. At a time when over 25% of applications for credit and 30% of mortgage requests are refused there is obviously a large market that is relatively under developed in the UK. This is a fact recognised by one leading UK mortgage provider who is said to be creating a sub prime division. When one considers that the sub-prime market is estimated to be growing at 20 percent per year, lenders approaching this sector with professionalism have enormous potential for growth, from both a profit and customer base perspective.

Look to the US for vision of the future
In the US, sub-prime lending has been one of the fastest growing of all industrial sectors. During the early 90’s, the US sub-prime specialist Green Tree grew at a compound rate of 83% on the New York Stock Exchange. Competition in the US sub-prime mortgage lending market has also intensified in recent years. Established mortgage providers such as GE Capital, KeyCorp & Chase Manhatten are targeting the sub-prime market as well as companies specialising in this particular market. The UK market is still behind the US but is realising the benefits of being involved.

The sub-prime market in the UK has, to some extent, been ignored by UK financial institutions, leaving the way for clear for US entrants to the market. However, as blue-chip risks become harder to find and therefore the margins on these loans erode, it is likely that more UK lenders will look closely at the sub-prime market. Based on independent research during 1998, the UK sub-prime mortgage market alone was valued at £13 billion and is still growing significantly to date.

However, lenders entering this market have to take a new approach to choosing their customers. To maximise the potential in the sub-prime sector, lenders need to assess each risk individually. For a company to enter the sub-prime sector there are some decision-making hurdles to overcome:

  • If presently using a manual underwriting approach to lending, a company may not have the necessary expertise or resources to expand into this new area
  • If using a combination of scorecards and underwriting, the present scorecard may not be relevant to this new sector as it will not have been modelled on this unique profile of customer

Looking Towards Technology

To succeed, organisations are already realising the need for more advanced technology that can offer real time decision making that is both fast and accurate, whilst facilitating assessment of the applicant as an individual.

Technology is playing a major role, as adaptive learning solutions, such as Decider™ decision-support solution from Neural Technologies, ease the sub-prime assessment risk. Decider™ produces bespoke scorecards based on past lending decisions and results. It continually evolves by learning from new data and the outcome of new lending decisions meaning it stays constantly fresh and accurate.

Credit Scoring

Credit scoring has been in use for many years. This technology was introduced to enable companies to overcome the problems associated with the ‘underwriter only’ approach to credit granting decisions. This is not to erode the professionalism of any individual but merely states that additional benefits can be achieved when underwriting expertise is directed to specific applications.

Credit scoring should not be thought of as the final decision-maker, it is better thought of as a decision-support tool that helps an organisation to better concentrate its underwriting resources. The main advantages of implementing a credit scoring system are that it provides a company with:

  • Objective decision-making by treating each risk individually
  • The ability to concentrate underwriting resources on the marginal cases
  • Control and regulation
  • Design flexibility so that customers and/or products can be segmented. This is especially useful when cross-selling other products or services


Growing competition means future financial institutions that will only lend to class A or low risks will find it hard to succeed in the UK or the increasingly global market place, without drastically cutting margins. Sub-prime lending provides a high growth opportunity for UK institutions and can be highly profitable.

In America, sub-prime lending is the industry’s fastest growing sector. The sub-prime market in the US is estimated to be $60 billion with an annual growth of 15%. It is expected that the UK market will grow at least as quickly, perhaps more so, as the UK is, by comparison, a relatively under developed market for sub-prime lending. Some commentators also suspect that mainstream credit scoring systems have not kept up with the structural changes that took place in the employment market since the recession of the early 1990’s. This means that many more people fall into the sub-prime market than may be strictly necessary.

The most important message is that “a high risk does not necessarily mean a bad risk”. However, any company entering this market will have to change its underwriting approach. An adaptive credit scoring approach has the capabilities to aid the credit granting decision-making process and can help any company entering what is going to be a fast growing and highly profitable sector of the credit industry.

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