Two Sides, One Coin: Credit Risk Management and Consumer Protection

For asset finance companies, credit risk management and consumer protection are inseparable. If a company wants to protect its customers, it needs to make sure they understand the terms of any loan contract they sign and can comfortably make repayments. Conversely, if that company wants customers to actually pay for their financed assets, it needs to treat them honestly and fairly, and ensure they’re satisfied with their product.

CGAP has spent the last two years working with asset finance companies to help them improve their credit risk management. Asset finance differs from other forms of lending like microfinance and digital credit in key ways: opaque pricing dynamics, swift and tangible consequences of nonpayment (e.g., lockout for pay-as-you-go (PAYGo) loans), and flexible financing terms. The result is a complex set of provider-customer interactions that expand financial options for low-income consumers but create new consumer protection risks. If realized, these risks could result in consumer harm and non-performing assets.

Working with the GOGLA Consumer Protection Team, CGAP has identified two areas of business where consumer protection concerns and credit risk intersect — and where businesses can improve their portfolio quality while safeguarding consumers.

1. Pre-sale: marketing and assessment

Customers need to understand the product they are purchasing to make an informed decision. In asset finance this is doubly complicated because the “product” consists of both a physical asset and a financial obligation. This means that asset finance companies need to clearly communicate both the cash price of an asset and the total cost of ownership for a financed purchase.

Regarding the latter, being clear about the effective interest rate and expected interest cost helps customers to understand the true cost of financing and make meaningful comparisons with other financing options. It is also important to communicate the expected repayment frequency and the penalties for nonpayment (lockout, repossession, etc.). Flexibility in financing terms creates ambiguity for customers; providers need to dispel that ambiguity.

Clear communication is not solely a consumer protection issue. Customers, even experienced customers, who do not understand payment terms are at higher risk of early default. Working with a solar finance company in East Africa, we observed one client take a small cash loan from her PAYGo provider, in addition to a solar loan, and then quickly default when she realized she was expected to service both loans simultaneously.

Clear communication is not solely a consumer protection issue. Customers, even experienced customers, who do not understand payment terms are at higher risk of early default.

Companies also owe it to themselves and their customers to assess a prospective customer’s ability to repay a financial obligation. Without a proper credit assessment, clients can be oversold a product and find themselves under financial stress. In 2019, 5% of off-grid solar customers reported regularly cutting back on food consumption to make payments.

But credit assessments at the last mile are hard. Agents who are commissioned on sales will always be incentivized to approve a client. Even when commissions are tied to collections targets, an agent can only ever make money by making sales. Someone else needs to conduct the assessment and verify the data collected (the "four eyes" principle).

Collecting data on customers’ demographics, occupation, income and assets over multiple loan cycles can improve the accuracy of a company’s credit assessments. Multiple companies CGAP worked with had experimented with blanket financing; any potential client with enough money for a deposit could take home an asset, without providing much or any data. This typically led to repayment issues. When these companies adopted more robust screening methods (ID verification combined with a credit assessment over the phone), collection rates improved.

Despite these benefits, the cost of assessment may exceed the gross margin for assets such as lanterns and cookstoves. In such cases, companies can price in the actual risk of default and make the product more expensive. Alternatively, they can tighten their credit terms and require higher upfront deposits or shorter repayment periods.

Both of these approaches make assets more expensive for low-income clients, and finding the right balance between affordability and risk management is difficult. Another solar finance company found that mining workers were defaulting at higher-than-average rates and responded by reducing their loan tenors. This made monthly repayments more expensive for the miners, but the company reduced its risk exposure and kept operating.

2. Post-sale: service and collections

Customer satisfaction with the physical asset strongly influences repayment behavior. When an asset stops working, people are likely to stop paying for it. Having high-quality assets and a means of fixing them are cornerstones of successful asset finance. In data from 60 Decibels surveys, clients with unresolved service challenges were 30% more likely to report that they had reduced payments to the company. Warranties are an important mechanism to de-risk investment for customers, but there is no substitute for effective customer service.

Customer satisfaction with the physical asset strongly influences repayment behavior. When an asset stops working, people are likely to stop paying for it.

When customers make payments, they should be able to clearly see how much they have paid along with their remaining balance. If customers stop paying, responsible collection means informing them of the consequences and following through on those actions. This is an area with severe potential for abuse, so clear policies and procedures for client-focused messaging, triggers and decision-making for collections activities are fundamental to protecting consumers and maintaining portfolio quality.

Companies sometimes monitor their repayment by grouping customers into monthly vintages based on when their loan was originated. There is a similar opportunity to monitor consumer protection on a vintage basis. This would enable companies to see how newer cohorts compare to older ones in areas such as product satisfaction or complaint resolution. Likewise, monitoring those same outcomes by product, geography and customer segment could yield actionable insights. Just as in portfolio management, capturing and managing data is crucial to monitoring consumer outcomes.

Improving credit risk management to achieve consumer protection

Long-term, a lack of effective credit risk management hurts a company’s customers, its reputation and its bottom line. Rapidly growing receivables are only good if they reliably turn into cash.

The GOGLA Consumer Protection Code, developed with the help of a working group that included CGAP, establishes a standard for companies to live by. It consists a set of principles and a self-assessment tool for companies to measure and monitor performance on critical areas of consumer protection. The PAYGo PERFORM KPIs being developed by CGAP, GOGLA and Lighting Global also contain indicators that are relevant to portfolio quality and consumer protection.

Now is the time to self-assess, take stock and make sure that your company has the people and policies in place to manage credit risk and protect consumers. Keeping an eye on both sides of that coin will help asset finance companies grow their businesses, and their impact, sustainably.

For more insights into how asset finance companies can better manage credit risk, see CGAP's new technical guide: "Getting Repaid in Asset Finance: A Guide to Managing Credit Risk." Dan Waldron is head of insights at Acumen. Before joining Acumen, he led CGAP's work on credit risk management in asset finance. Rebecca Rhodes is a project manager for consumer protection and technology at GOGLA. Roan Borst is a project manager on GOGLA's Performance and Investment Team.