Collections 3.
0
Bad debt collections:
From ugly duckling to white swan
Outgrowing the
ugly duckling
The consumer lending environment in South Africa has
become materially more competitive. Relatively new
lenders are gaining a stronger foothold in the market
and competition from non-traditional lenders such as
retailers, is becoming more common place. Customers
in turn are not loyal to one lender and have multiple
credit relationships, which has pushed many lenders
to reconsider their collections strategy. To put this into
context, it was recently reported that there are now
5.8 million more credit active consumers than there
are people employed in South Africa, indicating that
consumers are likely to have more than one account.
Based on comments by some financial research
analysts, it is likely that many consumers have over
four accounts1.
There has been an upward trend in the growth of
credit transactions over the past few years and this
trend is likely to continue as the economy grows.
While, credit extension has not been as aggressive as it
was before the introduction of the National Credit Act
the growth seen is substantial enough to require an
effective collections strategy.
Number of transactions
Credit granted by type (number of credit transactions)
40 000 000
35 000 000
30 000 000
25 000 000
20 000 000
15 000 000
10 000 000
5 000 000
Mortgages
Secured credit
Credit facilities
Unsecured credit
Shortterm credit
Q4
8-
0
20
Q4
9-
0
20
Q4
0-
1
20
Q4
1-
1
20
Source: National Credit Regulator
1 BNP Paribas Cadiz Securities. May 2012. Moneyweb
Collections 3.0 Bad debt collections: From ugly duckling to white swan
Gross debtors book by credit type
2008 Q4
Gross debtors book by credit type
2009 Q4
1%
1%
5%
14%
5%
Mortgages
15%
15%
Secured credit
Mortgages
15%
Secured credit
Credit facilities
65%
Credit facilities
64%
Unsecured credit
Unsecured credit
Short-term credit
Short-term credit
Gross debtors book by credit type
2010 Q4
Gross debtors book by credit type
2011 Q4
2%
2%
5%
16%
5%
Mortgages
13%
19%
Secured credit
Mortgages
Secured credit
12%
Credit facilities
64%
Credit facilities
62%
Unsecured credit
Unsecured credit
Short-term credit
Short-term credit
Source: National Credit Regulator
Unsecured lending as a share of overall credit exposures has increased over the past four years as a result of
increased lending.
South African housing price averages (year-on-year growth)
32%
23%
21%
17%
14%
15%
15%
15%
7%
4%
2%
0%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source: ABSA. January 2012. House Price Indices
With a slowing in South African housing price growth, reliance on security to mitigate credit loses is no longer the
only collection strategy.
Lenders are increasingly looking to gain a competitive
advantage through the introduction of market leading
risk-based collections strategies and operations.
Collections 3.0
to enhance the quality of predictive analytics,
decision making and recovery rates, but only where
these external service providers generate value to
the business that cant be achieved internally.
Enhanced reporting. Real-time metrics captured in
an executive dashboard can improve management
visibility of performance and thereby ensure more
responsive and informed decision making.
A risk-based collections strategy encompasses the
following key areas:
Insight from sophisticated behavioural models.
Predictive analytics improve decision making and
efficiency by analysing a wide set of customer data
to determine the risk level of each account and/
or customer, and therefore the most appropriate
treatment strategy. This operational strategy aims to
ensure that the right treatment and mechanism is
used at the right time and at the right cost for each
account or customer segment.
More efficient, effective processes. Increasing the
automation of collections activities make collections
processes significantly more efficient and effective.
Organising activities by the risk level of accounts
and customers adds to the efficiency gains with low
value activities automated and high value activities
aligned to the most experienced collectors.
An extended business model. External data
providers and debt collection agencies are
increasingly being used by successful organisations
Alignment across the credit lifecycle. Aligning
sales and marketing, finance, risk management,
pre-delinquency, collections and recoveries functions
ensures that the lessons learnt from each function
and credit lifecycle stage are shared across the
organisation to minimise losses and maintain
control.
A robust technology infrastructure. Underpinning
all these enhancements is a strong technology
infrastructure. Successful collections departments
use data mining to assist in segmenting the portfolio
and developing the predictive analytics model. They
have a well-developed capability to rapidly develop
and deploy these predictive models and strategies.
They employ decision engines that automatically
determine the appropriate treatment strategy for
each account/customer. Finally they have workflow
systems that reduce costs by automating the
collections activities driven from decision engines.
What are predictive analytics?
Insight from
sophisticated
behavioural
models
More efficient,
effective
processes
More accurate
metrics
An organisations data is full of potential. Stored throughout
the business, is a wealth of possibilities. Leading financial
services providers recognise that a better understanding of
data (particularly as a predictor of the future or as an identifier
of existing issues) can create new opportunities and make a
significant difference to managing performance. Predictive
analytics is a set of statistical tools and technologies that use
current and historic data to predict future behaviour.
Collections 3.0
Predict
What might happen
in the future?
An extended
business model
Monitor
Whats happening
now?
Complexity
A robust
technology
infrastructure
The risk-based collections
approach
Alignment
across the
credit lifecycle
Analyse
Why did it
happen?
Enhanced
reporting
Report
What happened?
Business Value
The Collections 3.0 model
Collections 3.0 Bad debt collections: From ugly duckling to white swan
More accurate metrics. Some institutions are
moving beyond traditional measures, such as total
rands collected and cost to make a call, to employ
cost to collect R1 metrics that more accurately
measure the return on collections spending, and
facilitate more robust decision making.
Currently, certain financial institutions are faced with
under-performing collections and recoveries functions
due to general under-investment over the past few
years in the function, in an effort to lower costs.
Ignoring collections, as though it were the ugly
duckling, has resulted in these financial service
providers having out of date systems, data and skills
in this function of the business. Collections functions
have also generally been viewed as a cost centre,
rather than a revenue recovery centre, and have
therefore not received the necessary investment
required to enhance efficiency and effectiveness,
and in so doing have reduced the ability to further
increase profitability and performance. Combining
these concerns with new consumer regulation such as
Treating Customers Fairly and the Consumer Protection
Act and risk-based regulations such as Basel II and
III has created the need for lenders to adopt a more
risk-based approach to collections. Those lenders that
do embrace risk-based collections gain a significant
first mover advantage through enabling increased
collections, better credit decisions, and reduced
operating expenses.
Finding the swan
hiding in the data
Most financial service providers find that their
collection efforts are inefficient relative to the
experience of the global market, which indicates
that efficiencies can be found across the entire
collections lifecycle from pre-delinquency to write
off and recoveries. If financial service providers with
inefficient collections functions continue with their
current collection strategy, collectable balances older
than fifteen months will continue to provide minimal
return. These financial service providers will also have
difficulty in determining whether the cost of collection
outweighs the return on these collectable balances.
In an effort to assist in realigning the collection
and recovery function Deloitte has developed the
Collections 3.0 approach. This approach, which
encompasses both a quantitative and qualitative
component identifies areas of improvement within the
collections and recoveries space, as well as comparing
completed accounts (i.e. non-performing accounts
that have either cured or written-off) loss figures
against industry peers. Collections 3.0 involves
the processing and transforming of default data for
various purposes and by using a standard loss-given
default (LGD) calculation to run the data, the losses
experienced on the completed accounts and trends
can be analysed over time.
Cumulative Recovery
Recovery by Period
Duration
Market Cumulative Recoveries
Client Cumulative Recoveries
Market Implied LGD
Client Implied LGD
Cumulative recoveries on a lenders defaulted book. (fictitious data)
Collections 3.0 Bad debt collections: From ugly duckling to white swan
The completed accounts loss figures can be compared
across the banks and from this, various metrics can be
extracted, including for example:
Write-off policy impacts
Debt-counselling impacts
Impact of restructuring
Compared write-offs over time
What is Collections 3.0?
Collections 3.0 involves a qualitative and quantitative combination of analysing
the current state of a collections and recoveries function and benchmarking
it against peers, thereby enabling efficiency gaps within the function to be
revealed. Then through the use of predictive analytics a new and enhanced
target operating model can be developed and optimised for the collections and
recoveries function. This target operating model can be tailored to the credit
base, enabling increased efficiencies to be realised.
Current state analysis
Benchmarking
Collections 3.0
Target operating model design
Predictive analytics
The Collections 3.0 difference
The qualitative aspect of the Collections 3.0
approach also involves the use of a proprietary tier
structure model for collections and recoveries. This
tool facilitates quick and effective comparison of the
relative sophistication of an institutions collections
organisation. The comparison is made across a number
of high level elements, each of which assessment
is based on a more detailed analysis of lower level
aspects of performance. It allows mapping of as is
and to be positions and so can be used to illustrate
a programme for change to transform the collections
organisation. The following table illustrates the
continuum of practice between traditional collections
and the risk-based Collections 3.0 approach.
High level Tier Structure Model (TSM) for collections and recoveries
Traditional collections
Tier 1
Transitional collections
Tier 2
Tier 3
Risk-based Collections 3.0 approach
Tier 4
Tier 5
No formal co-ordinated
setting of a credit risk
management strategy
(including collection and
recoveries).
A strategy for credit risk
management set at a Group
level is not clearly linked into
business strategy.
Risk management strategy is
communicated and accepted
across the business units,
with clear objectives in line
with business strategy.
The strategy is adopted by all
business units and it is
integrated into all risk classes.
Strategy is dynamic in nature
and focused on specific
customer characteristics.
The strategy is totally
embedded into the businesses
and fully integrated into other
risk classes. Champion versus
challenger methodologies
fully embraced.
Roles and responsibilities are
not defined or clearly
allocated for credit risk.
No clear role for risk within
the organisation.
Some roles and responsibilities
are defined in a co-ordinated
fashion generally focusing
on Group centre. Risk is
recognised as a clear role in
the organisation.
Individual roles and
responsibilities are aligned
to the individual
components of credit risk.
Risk primarily seen as cost
centre.
Duplications are eliminated.
There is clear role and
responsibility allocation
between Group centre and
business units. Risk increasingly
seen as profit centre.
There is fully optimised and
cost efficient model in place
with all responsibilities
clearly defined. Risk is seen
as business enabler.
Collections and
recoveries
definitions
No clear and universal
definition of collections and
recoveries terminology
exists.
Collections and recoveries
definitions are defined in
some business units but not
others.
Multiple definitions of credit
risk exist across the
organisation, with no clear
distinction between fraud,
credit abuse and credit risk.
There is a single set of
definitions but they are applied
or interpreted in an inconsistent
manner across the organisation
with respect to specific measure
and timeframes.
There is a single fully
integrated set of definitions
used consistently across the
group.
Processes and
methodologies
qualitative
There are limited formal
processes for management
of credit risk, uncoordinated
across the organisation.
There are Group-defined
processes for managing
credit risk, but which lack
robustness and business
buy-in.
There are methodologies
and tools which are
consistently applied by the
business units.
There is a complementary
and integrated suite of tools
to cover each aspect of the
process.
An optimal control
framework, including full
cost vs. benefit analysis of
the methodologies
employed.
Processes and
methodologies
data and
analytics
No formalised or
co-ordinated collection of
credit risk data.
There is some tracking of
credit risk data, although
not complete for all business
lines.
There is complete coverage
of loss and transaction data
across all business units.
Internal data predominantly
used.
External data used to
supplement internal data. Loss
information collected is
largely accounting based and
customer contact information
poorly structured.
The organisation has
complete economic loss data,
seamlessly incorporating
internal and external data,
including detailed customer
contact information.
Processes and
methodologies
quantitative
No formal quantitive
measurement of credit risk
(collections and recoveries
elements).
Some form of credit risk
(collection and recoveries
elements) quantification
takes place using collections
scorecards.
Credit risk (collections and
recoveries elements) is
quantified using collections
and recoveries scorecards.
Risk quantification models
take into account alternative
communication media and
strategies.
Risk quantification models
used to optimise collections
and recoveries performance
by considering all tools and
strategies available.
Communication
and information
flows
There is no formalised
management reporting of
credit risk and an
unsophisticated customer
communication strategy.
Some reporting formally
defined for management at
a Group level. Customer
communication strategies
are more formalised but still
unsophisticated.
Reporting supports decision
making and the proactive
management of credit risk,
used by Group and business
units. Multiple
communication media used.
Reporting is embedded in the
businesss day-to-day activity
and is integrated across risk
class. Communication media
varied and determined by
scorecards.
Reporting is fully automated
and real time. It is fully
integrated with other risks.
Sophisticated multiple
communication media can
be employed.
Skills and
resources
There are only a few
individuals within the
organisation who have
necessary collections and
recoveries skills.
Collections and recoveries
risk management roles are
generally populated by
individuals with necessary
skills.
Collections and recoveries
responsibilities within the
business units are discharged
by individuals with appropriate
credit risk skills supported by
appropriate training.
High degree of understanding
of collections and recoveries
skills across the organisation,
supported by training,
incentive schemes and
competency model.
Effective allocation and use
of resources efficiently
applying the skills sets of
existing resources.
No formal validation of the
credit risk management
framework occurs.
Internal audit include the
credit risk management
framework in their reviews on
an ad hoc basis.
Internal audit provide
formal assurance to the
Board of the validity of all
aspects of the framework.
Stress tests of qualitative and
quantitive factors to assess
the future validity of the risk
management framework.
The credit risk framework
contains embedded
validation and assurance on
a real-time basis.
Strategy and
policy
Risk governance
and organisation
Validation and
assurance
Continuum of practices
Collections 3.0 Bad debt collections: From ugly duckling to white swan
Transforming from ugly
duckling to white swan
Deloitte has been working with a number of clients
across the globe for the past seven years to transform
their collections and recoveries operations. In Ireland,
we have spent the last 18 months transforming a
banks collection function with significant results.
When we began working with the client the economic
environment in the country was deteriorating rapidly
with unemployment increasing and housing prices
falling. In the political environment the blame the
bankers concept was resulting in trade unions
encouraging their members to boycott making
mortgage payments. There was also an increased
swing towards consumer protection in the context of
collection strategies but also increased occurrence of
strategic debtors.
The original business case for the transformation was
to improve efficiency by 25% and effectiveness by
15%. By February 2012, the Collections 3.0
transformation journey enabled efficiency
improvements of circa 35% and effectiveness of
circa 22% to be realised at a time when the credit
environment was still worsening.
A business case for collections transformation: Deloittes experience with financial service providers in Ireland
What needed to be addressed?
What was the result?
Strategy, Appetite and Policy
Champion versus challenger strategies were not
embedded.
Strategy, Appetite and Policy
Champion versus challenger strategies became
embedded into the collections culture and within
reporting, including in standard management
information (MI) packs. Collections strategies became
fully aligned to organisational risk appetite.
Risk governance and organisation
There was a lack of end-to-end credit risk lifecycle
alignment.
Risk governance and organisation
Greater interaction between the collections, recoveries
and the credit risk function (covering acquisition and
account management processes).
Delinquency definition
Internal definitions were not aligned to regulatory
definitions and confused the strategy implementation.
Delinquency definition
Definitions aligned to regulatory definitions became
widely documented and understood.
Processes and methodologies Qualitative
There was no evidence of consistent process
implementation that was aligned to strategy
Processes and methodologies Qualitative
Collection processes became fully documented and
embedded into collection systems, increasing process
and regulatory compliance and efficiency of collections
operation.
Data, Analytics and IT
An under-investment in infrastructure meant it
was fragmented which limited the efficiency of the
operation.
Data, Analytics and IT
The integration of technology and data infrastructure
allowed greater strategy automation and associated
reporting and MI benefits.
Processes and methodologies Quantitative
There were no quantitative models in place within
collections.
Processes and methodologies Quantitative
Risk based collection models embedded into collections
processes.
10
Communication and information flows
Poor data infrastructure limited the timeliness and
accuracy of MI.
Communication and information flows
Robust communication plans were put in place, and
MI was transformed to provide both operational
and financial performance at sufficient enough
granularity for on-going strategy development and post
implementation reviews.
Skills and resources
Key skills had been lost since last recession, and no
robust training and development plans had been put
in place.
Skills and resources
Training and development plans were put in place.
A competency framework was developed and the
operating model became aligned to the skills set of
teams.
Validation and Assurance
Validation and assurance had been undertaken on
ad-hoc basis by Internal Audit and Compliance.
Validation and Assurance
A specialist collections compliance manager was
recruited, and organisational design changed to include
a training and development manager responsible
for call listening and process assurance, which has
increased the control framework.
Collections 3.0 Bad debt collections: From ugly duckling to white swan
11
The Collections 3.0 transformation journey
Phase 1:
Collections and Recoveries
Benchmarking
Phase 2a:
Target Operating Model
Development
Phase 2b:
Quick Wins and Soft Skills
Transformation
Phase 2c:
Support Infrastructure
Transformation
Phase 2d:
Management Information
(MI) transformation
Phase 3a and b:
Strategy Transformation
(including late arrears)
Phase 3c:
Predictive analytics
transformation
12
Review of the entire collections and recoveries function including its interaction with other functions
in the organisation (including risk management, legal, compliance, internal audit and customer
services). This facilitates the establishment of an as-is review and maturity assessment of the current
environment in light of the Tier Structure Model (TSM) (qualitative benchmarking). The relative
strength of the collections and recoveries function can also be achieved through a quantitative
benchmarking exercise, using market data to standardised internal Deloitte models (quantitative
benchmarking).
This phase incorporates a thorough review of existing operating model and the development of
a clear vision for a Target Operating Model (TOM) for collections across various domains such as
strategy, processes and governance. This enables the organisation to establish a coherent vision for
their collections and recoveries function.
Instigation of a Collections and Recoveries Transformation Programme relating to quick wins (i.e.
those matters that will require little investment, but offer a large return in the short term) that is
designed to focus initially on improving the softer skills and implementing quick wins within the
collections and recoveries functions.
Efficiency and effectiveness improvements within the collections and recoveries function may require
some major changes to the data and IT infrastructure of the lender, and specifically better integration
of the lenders systems.
Following on from data and infrastructure developments, it may be necessary to devise a
comprehensive set of collections metrics and reports to support efficiency and effectiveness
improvements in their collections operations and associated strategies. This will cover financial MI,
collections MI, operational MI and customer and product MI.
Improvement to the lenders data and IT infrastructure may result in a major shift in the effectiveness
of its operations. This is as a result of greater automation of low value processes, and a more
standardised approach to collections strategies. However in order to improve the effectiveness of
the collections operation, it is important that the appropriate strategy is designed, managed and
developed first.
In order to fully optimise collections it is important to incorporate behavioural analytics into the
collections and recoveries function. This includes the identification of customer-level scoring drivers
for pre-delinquency, recovery and litigation levels. If necessary, the lender may also wish to develop
Basel III and IAS 39 compliant models.
The appeal of the swan
cannot be denied
Better understanding as to what drives recoveries not
only allows management to increase the bottom line,
but also provides a strategic mechanism to further
entrench market share, achieve business growth
and enhance shareholder returns. The outcomes of
improving collections processes can have additional,
frequently unexpected benefits such as deeper
customer insights, which in turn enable better and
more efficient collections strategies.
Benefits of adopting the Collections 3.0 approach
Through incorporating a risk-based collections strategy, many of our financial services clients have been able to realise
tangible benefits such as:
Improvements of up to 20% in
Rands collected
Reductions of up to 30% in
cost to collect
Payback on investment in
technology usually within 12
months
Charge-off reductions of up
to 10%
Enabling roll-rate declines
Identifying potential risks to
the business
Improving the efficiency and
effectiveness of the collections
function
The ability to make
comparisons against
benchmark measures
Effectively comparing
operations against competitors
using consistent definitions
Improved customer retention,
by eliminating calls to those
likely to pay without contact
Reduced call volumes, making
more efficient use of call
centre resources
Identifying new opportunities
for revenue streams as well as
cost reductions
In addition to the bottom line benefits available through investment in risk-based collections, there are substantial intangible
brand-enhancement benefits from which clients could benefit. Through better understanding who the most risky collections
customers are, and through better tailoring strategies for contacting them and recovering in-arrears funds, lenders can
dramatically reduce unnecessary or mis-timed customer contact. This has enabled our clients to realise the following intangible
benefits:
Facilitating a better marketing
strategy through a more
targeted approach
Improve customer retention
efforts through better
customer understanding
Understanding the market
trends and how they impact
on the business
Overcoming obstacles to
adjust to new trends
Collections 3.0 Bad debt collections: From ugly duckling to white swan
13
Become the swan
Due to the wide uptake of credit in South Africa, the
collections function is increasingly becoming a key
focus to any lending organisation. To grow out of
the ugly duckling and embrace the swan, requires
an understanding and a willingness to optimise
collections strategy, governance systems and data.
Aligning this knowledge throughout the organisation
is important. The Collections 3.0 approach is
emerging, which combines predictive modeling
techniques with the increased productivity achieved
by automating collections activities, improving metrics
and realigning the organisational structure.
14
Lenders that migrate to these greater levels of
collections sophistication will capture substantial
benefits in lower operating costs, a higher rate of
promises kept, more Rands collected, greater brand
loyalty, and more satisfied customers. An institution
that creates a truly risk-based collections organisation
will achieve a significant advantage in an ever more
competitive industry.
Contact us
Damian Hales
Partner
dhales@[Link]
Pravin Burra
Director
pburra@[Link]
Derek Schraader
Director
dschraader@[Link]
Jonathan Sykes
Senior Manager
jsykes@[Link]
Collections 3.0 Bad debt collections: From ugly duckling to white swan
15
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