By: Abhik Kar and Senthil Kumar A L

According to a recent survey in the United States of America, 32% of millennials claim that their loan applications have been rejected while applying for mortgages, car loans, credit cards, and other credit-related products. This segment of customers is referred to as ‘Thin-File,’ which means they do not have adequate credit history to be evaluated for credit decisions. More than 62 million customers in the Dare ‘thin-file’ customers, who are credit-challenged, and this continues to be the trend in other geographies as well. As per tradition, credit assessment models always lean on the credit history of an individual when assessing their worthiness. This results in a significantly higher number of rejections in credit applications. While credit risk becomes an important aspect to factor in, higher rejection causes a loss in opportunities and lets prospects go to competitors. Traditional banks and lenders are concentrated on history, while contemporary credit models are exploring new avenues to identify the end use of credit availed by the customer. In this regard, Environment, Social and governance (ESG) can be a significant differentiator. ESG, through Sustainability Linked Financing (SLF), can assess a credit application with ESG-based scoring and define the rating for each application. The same applies to small businesses that do not have sufficient credentials when it comes to supply chain or invoice financing.

Underbanked and Thin-File Customers

Losing segments of customers who broadly depend on cash or are underbanked is a challenge for banks today. While the pandemic has forced these cash-only customers to move online and transact over mobile banking, they still lack credit history. Hence, there should be other alternative ways to recapture these rejections and reevaluate. There is a need for another attribute that can help these customers who intent to contribute to the environment and social improvement. Hence, ESG, as an additional attribute, can help banks take a look and give a second chance to the rejected lot.

Carbon Footprint Reward

Contributions to a reduction in carbon footprint can be rewarded with ESG points, and this can be used to enhance the credit worthiness of the customer, which banks and financial institutions can integrate into their credit decision process. ESG opens up one such unique and innovative way to rethink and recapture the rejection. This in turn will encourage customers towards ESG products such as electric vehicles and solar-enabled homes.For the business, it will encourage more engagement in contributing towards environmental and social improvement. At the same time, banks will be able to recapture potential customers from the rejected queue and expand their market share as well.

How Do We Address This High Level of Rejection?

Customers are heavily stressed by the fact that rejections are on the higher side due to their lower credit scores. Banks are losing customers who are not able to meet credit-scoring thresholds. However, these customers have good intentions and may be loyal and profitable.

• Therefore, an ESG-based solution can be developed to award customers based on their ESG contribution when they apply for the loan.
• Award the customer green points for their contribution towards environment and society in the recent past.
• This ESG contribution is quantifiable, and there are recognized indices available in the market that are open API-based, such as the Alan index, which can be easily leveraged.
• Consider rejected customers who are marginally below the threshold for approval as per the traditional credit-decisioning model.
• Open Banking solutions through connected APIs coupled with Artificial Intelligence can provide banks with data-driven insights into an individual or a business contribution to ESG from their day-to-day banking transactions, payments, and loans.
• Based on the analysis and the extent of contribution, ESG-related transactions initiated by customers can be converted to Green Points that can be integrated with the traditional credit scoring mechanism. For instance, if the customer’s credit points are 700, while the benchmark is set at 750, and if the customer has scored 50 Green points, the application can be taken forward for approval instead of outright rejection, considering the fact that the ESG score depicts that the customer’s “Character” in the lending principle stands out.
• Therefore, an ESG Rejection Recapture (ERR) solution can help increase loan origination volume and engage customers in a long-term relationship.

How Will It Impact Banks And Financial Institutions?

ERR can help retail customers and small businesses avail loans, provided they have contributed towards environment and society in the past or intend to, as part of the applied loan. Hence, this is a great opportunity for banks to tap the customer segment, which is rejected marginally because of thin files or insufficient credit history.

Value proposition for banks and FIs

• New revenue stream – Green card, green loan, green deposit.
• Increase in loan applications – 10-20% increase in credit portfolio
• Increase in rejection recapture – 30-40% of rejection recapture and increase in new customer base
• Increase in customer engagement
• Increase in CSAT (Customer Satisfaction) score
• Increase in contribution towards ESG

Key TakeAway

It is time for banks to move forward from the traditional way of credit assessment to the new age and look through an ESG lens. Environment and social responsibility are becoming a mandate for many jurisdictions, and soon, it will be a new regulation to adapt. In fact, the UN has already framed and released certain mandatory reporting requirements. Today, banks can readily avail indices available in the market and build their own model on top of that, in order to create an ESG framework. ESG framework and ESG products have now moved from banks’ wishlists to must-haves for fulfilling their interests and goals.