Seven Innovative Strategies for Smaller Commercial Banks to De-risk Borrowers

15 Jan 2022

15 min read

In a world increasingly driven by technology, data, and digital marketing, smaller commercial banks must leverage these resources effectively to de-risk borrowers, reduce default rates, offer competitive pricing, and expand their reach. Here, we present seven strategies that they can employ.

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Leverage the power of data, technology, and digital marketing to de-risk borrowers.

Innovative Strategies:

De-risking Through Financing Instead of traditional fixed loan models, banks can explore more innovative financing methods such as revenue-based financing or factoring, which align the interests of the bank and the borrower. These methods reduce risk as repayments are directly linked to the business's performance, thus reducing the probability of default.

Key Lesson: Embrace innovative financing methods that correlate repayments with the borrower's capacity, thereby reducing default risk.

Ensuring Repayment Behavior: Advanced analytics and machine learning models can be employed to analyze past repayment behavior, identifying key characteristics of borrowers that indicate a higher likelihood of timely repayment. Banks can use this information to make informed lending decisions and to create products that encourage such behavior.

Key Lesson: Leverage data analytics and machine learning models to promote positive repayment behavior.

Focusing on Positive Selection: Banks can focus on customer segments that exhibit low credit risk but are underserved by traditional financial institutions. Using machine learning models, they can analyze demographic, behavioral, and transactional data to identify these segments and offer them personalized loan products.

Key Lesson: Employ advanced data analytics to target low-risk, underserved customer segments, thereby increasing market reach while controlling risk.

Aligning Incentives: Incentive alignment can be achieved by creating loan products that reward timely repayments with reduced interest rates or other benefits. This not only encourages borrowers to maintain good credit behavior but also improves customer loyalty and retention.

Key Lesson: Design loan products with aligned incentives to encourage timely repayments and foster long-term customer relationships.

Frequently Asked Questions

Smaller commercial banks can reduce their exposure to risk by adopting innovative financing methods like revenue-based financing or factoring. These methods link loan repayments to the business's performance, making it more likely that repayments are made as the business earns. This approach not only decreases the likelihood of default but also aligns the interests of the bank with those of the borrower, facilitating a partnership approach rather than a purely transactional relationship.
Data analytics, particularly when combined with machine learning models, plays a crucial role in enhancing lending decisions by allowing banks to analyze past repayment behaviors and identify characteristics that predict timely repayment. This information helps banks make more informed decisions, create tailored products that encourage positive repayment behavior, and focus on low-risk, underserved customer segments. By employing these technologies, banks can expand their market reach while controlling risk more effectively.

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