In commercial lending, banks rely on long-standing risk models to help inform their credit decisions. These models are based on historic data and have been built up internally over decades. However, given the dynamics of the pandemic and the unprecedented fiscal stimulus we’ve seen from governments around the world to counter it, extrapolating from the past is an approach that is no longer fit for purpose.
Alike to trade wars, natural disasters or, indeed, climate change, pandemics are by their very nature situations that are hard to predict or plan for. We can make assumptions based on what we have seen with similar events in the past, but no two are the same. Supplementing this view with forward-looking data, which takes into account future challenges that may arise, provides the much-needed foresight to make better credit decisions.
Take an example of a paper and cardboard packaging business – revenue from paper sales has reduced significantly in the last 12 months as businesses moved to remote work and instituted digital solutions such as DocuSign. However, on its balance sheet, year-on-year sales for the entire business in 2020 may not look too different to 2019. This is because the decrease in demand for paper has been offset by an increase in demand for cardboard as people who are under lockdown shop online and order items to their home. While the move towards paperless working is likely a permanent change from the pandemic, the increase in online shopping is unlikely to stay at peak pandemic levels once people are able to shop in person again. Therefore, if the business fast forwards 6-12 months, it could see a decrease in revenue that it hadn’t been expecting and therefore, hadn’t planned for.
In this example, the bank, armed with this data, takes a more consultative role and advises the business to take out a loan to support working capital while it explores new revenue streams. Equally, the business, armed with this data, takes steps now to future-proof its business so that it’s prepared for changes further down the line. In a fast-changing world, a timely change of course informed by insight and foresight is much preferred to 20/20 hindsight when it’s too late to avoid a problem.
With commercial lending, forward-looking data, such as projections of revenues, provide an additional means of understanding future risks. As these offer a glimpse of a possible outcome under certain assumptions, when combined with historical numbers, they give banks and borrowers a much deeper understanding and the opportunity to act with increased confidence.
The OakNorth Credit Intelligence Suite enables banks to look forward, not just backward, helping them get ahead of borrower financial hardship, industry-driven risk deterioration, and covenant breaches – thereby enabling the monitoring of loans with the same rigor used in underwriting. In other words, the bank is able to lend smarter, lend faster and lend more.