CCR and risk-based pricing posing problems for lenders

Comprehensive credit reporting (CCR) came into effect on 1 July this year. The banking sector has largely embraced the initiative, which will provide lenders with more detailed data around the credit behaviour of borrowers.

The main aim of CCR is to increase competition in the Australian financial services market.

“Put this together with the fact that these changes are occurring in a market which is experiencing increased regulatory capital requirements, slower growth and margin compression, and you have transformative change,” according to a Deloitte white paper.

However, with both the introduction of CCR and the introduction of open banking, what happens to those who are higher-risk customers? This question was posed by Deloitte financial services partner Paul Wiebusch during a media conference in Sydney last week.

“You can see what will happen for those who are lower-risk customers, who might be paying more than they need to at the moment,” Mr Wiebusch said.

“But at the other end of the risk spectrum, will this have an implication for higher-risk customers and potentially a desire to increase pricing for higher-risk customers?”

Mr Wiebusch warned that if lenders start to hike rates for higher-risk customers in an environment where the ACCC and ASIC are already looking into rate setting, there could be serious issues.

“You are also seeing a heightened focus on conduct-related issues,” the financial services partner said. “This has implications for some of the strategic options for organisations as they look at their pricing responses.”

Deloitte believes that financial institutions need to look at all three components of their pricing framework: profitability, price elasticity and customer lifetime value.

“By focusing only on current profitability, organisations may exclude customers whose risk profile, and profitability, will improve over their lifetime. If organisations focus just on risk, they could see a significant reduction in business, as people who are higher risk also tend to be more price elastic,” a Deloitte white paper noted.

“In addition, there is a higher risk of adverse conduct outcomes. Financial institutions should increase their pricing sophistication across each dimension — profitability, price elasticity and customer lifetime value — in order to mitigate the risk of unintended consequences.”

Deloitte noted that one example of unintended consequences is redlining — denying services to certain ethnic groups through selective price discrimination.

“In the United States, banks and insurers have been accused of defining zones in which minorities are unable to access financial services at reasonable rates (or at all) through an over-reliance on a risk-based view of the world.

“If credit is provided based only on a customer’s current credit scores, organisations risk ignoring an individual’s propensity to improve their credit risk profile over their lifetime.”