Can Technological Soldiers Like Blockchain & AI Helps Banks Prevent Bad Debts?
Bad Debts — It is an expense that a business incurs once repayment of credit previously extended to a customer is estimated to be uncollectible. It is a contingency that must be accounted for by all businesses that extend credit to customers, as there is always a risk that payments will not be received. Increasing bad debts directly affects a company’s financial performance since it lowers the revenue and thus the net profit for a particular period.
A report suggests, 65% of the worldwide banking executives expect that the branch-based model will be dead within the next five years, up from 35% four years ago.
Credit is an essential aspect of the banking empire. The primary function of a bank is to accept deposits and lend money to the borrower, who pays back the amount with a certain percentage of interest on it. That interest serves as revenue for the bank, and hence if such loans turn out to default, then the bank is badly impacted. Therefore, credit risk management is a vital process for the banking industry. With banking operating globally, it becomes crucial to manage the credit/loan a bank provides to its customers. The loan payments are always associated with a risk of default which can significantly impact the banks. Consequently, I would like to discuss how banks can improve debt collection by integrating technological innovations in their operation.
Banks usually use the credit score — a number which indicates how likely is the customer to pay back the loan — of a customer accompanied with some mortgage which ensures the recovery of the amount in case the borrower defaults in the future, which might turn into a bad debt from them. While this does give a partial assurance, it does not guarantee that there will be no bad debts since there are many reasons why a borrower might not pay the loan back. For instance, the recent COVID-19 pandemic had impacted people’s lives in a way no one had ever imagined. In addition, uncertain situations like job loss, medical emergencies, loss of a bread-earning member, and many more crucial factors are at play; hence, it is necessary to understand the customer and act accordingly. At the end of the day, banks exist to provide their customer with the best possible services and experience while ensuring profitability.
More than 60% of the bankers see new technologies such as cloud, AI, and APIs as the biggest driver of change for the next four years, up from 42% three years ago.
Permissioned and decentralized ledger, smart contracts, and reliability provided by Blockchain technology can be leveraged to create a transparent and trustworthy system of managing the loans effectively. It is vital to know your customers as much as possible while giving out loans so that the right customer gets the best possible offer as per their needs. The customer’s identity verification can be done faster and efficiently with the help of the smart identity feature of Blockchain. The smart property feature of Blockchain will also help manage the collateral provided by the customer. The collateral ledger will enable the sharing of information for better evaluation of borrower’s financial and asset position, auditability, and, more importantly, the elimination of double-spending.
Smart contracts act as regulators throughout the loan lifecycle, eradicating the possibility of anything that might go wrong and affect the process. Apart from acting as a regulator, smart contracts can also be used to collect the payments from the borrowers in an agreed manner, making the process hassle-free and smooth. The method of giving out a loan involves the process of consensus approval from all the respective participants. Since the Blockchain has a distributed ledger, it is easy for everyone to come to a consensus in real-time. Approved loans are then cryptographically signed and immutable when added to the previous block in the chain.
Banks have a huge customer base that needs to be provided with quality services accompanied by personalization. This means banks have a humongous amount of data about their customers and their transactions. It is rightly said that “Data is the new oil,” but only for those who can derive meaningful conclusions and correlations from that vast pool of data. Artificial intelligence (AI) can be leveraged to make use of such a large amount of data according to their needs. Nowadays, AI is being used almost everywhere in some or the other way making different processes efficient.
Banks can also count on AI technology in debt collection in numerous ways. First, AI can analyse large amounts of data and develop many concrete conclusions and correlations that can further be used to make pivotal business decisions. Second, AI can segment the large customer base into different categories based on variables like age, geographical location, transaction patterns, the scale of transactions, frequency of transactions, etc. This will help the banks identify which category a particular customer falls into, and depending upon that, they can provide them with tailored services. Third, the same data can be used to develop a new category-specific strategy to give out loans or collect loans. Apart from this, banks can also create new products or services for them in the future.
Four in five bankers believe that banks will seek to differentiate on consumer experience rather than products, according to an Economist Intelligence Unit (EIU) report for Temenos.
Customers’ demands have been on a constant rise, and they seek uniqueness in everything. Therefore, personalization of services is one way to make the process of debt collection an easier one. For example, sending out personalized messages or emails to spread awareness about different products and services offered by a bank or gentle reminders based on customer’s activity can make a huge difference. Similarly, while collecting debts, implementing a personalized approach to settle down the payment can surely increase the chances of an individual paying off their debts compared to a generalized system. In addition, an individual can be classified as a high-risk or low-risk person based on their previous credit history. This helps the banks decide whether or not to approve their loan in the first place, preventing the seed of bad debts even before it gets sown.
Blockchain and AI both hold a potential promise to radically reduce the risk of loans turning into bad debts by providing better insights and digital infrastructure. However, it has its challenges. Implementing such technologies must be done with utmost precision to ensure it doesn’t lead to significant side effects. The banking industry is one of the highly regulated industries, and bringing such a change will not be an easy path to walk on. The biggest challenge for the banks would be to shift towards a decentralized and distributed ledger which is opposite to their current operating system.
I would suggest that banks try and implement such technologies at a small scale to test them and then plan a large-scale operation. This will provide them with hands-on experience regarding how to go about integrating technological superpowers into their existing systems. Moreover, adequate training and a unified approach will help us overcome the obstacles in the way. With the ever-increasing tech-savvy generation and the deployment of technological soldiers, this can potentially become a painless transformation in how the banking industry functions for the better.
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