By Neill LeCorgne
Every little bit of earnings and efficiency gains helps banks as they work to fulfill the never-ending appetite for shareholders’ earnings growth expectations. Oftentimes, financial institutions will seek those efficiency gains through expense cuts and outsourcing back-office functions, such as payroll. But bank executives can exact more meaningful efficiency gains that also provide a strategic advantage for their lending operations by adopting loan pathing.
What is loan pathing?
Loan pathing is the process of mapping the path of various loan applications (typically for small- to mid-sized loans) based on the application’s characteristics in order to improve the handling. Simply put, loan pathing incorporates software automation and workflow management to fast-track the strongest applications to approval and fast-track the weakest applications to either denial, or a quickly restructured application that can meet institutional risk and return objectives, and can therefore, be approved. By speeding up the handling of applications on either end of the application spectrum, banks can ensure that the bulk of their resources are utilized for evaluating loan application in the middle risk range.
Obviously, bankers want to originate nothing but good loans. That is the ideal, but it is not a reality in the banking world today. As a result, one key goal is to make sure loans meet at least an “average” loan grade in advance of the next economic or market downturn. At a minimum, bankers do not want to be originating loans that clearly represent weak credit and excess risk for the return.
Too often, however, institutions create inefficiencies in the loan underwriting process by not differentiating between strong and weak loans. Too much time is wasted on the strong and weak loans and not enough time is spent on loans in the middle risk range. The result? A sub-par customer experience across all customer types, potential compliance risk, and inefficiency that not only wastes resources but can also result in loans lost to competitors that can respond more quickly.
How to create a loan path
To simplify the discussion of loan pathing, let’s identify the best loans in the market as “Green.” We’ll identify weak, non-bankable loans in this discussion as “Red,” and loans in between as “Yellow.”
Based on this description, it makes sense that financial institutions should be spending as little time as necessary on the Greens, with a goal of underwriting, approving, closing and onboarding these loans as quickly as possible. Time is of the essence. If you don’t close this loan, a competitor will.
At many financial institutions, however, very high quality loan applications scored Green get over-analyzed and over-evaluated relative to their risk. In fact, we often look at these loans in the same manner as higher risk loans, jeopardizing losing the deal and its corresponding interest income and cross-sale opportunity. We lose these deals through analysis paralysis to the nimble competitor who approves and closes the loan faster than us. After losing a deal, it is not uncommon for an institution to spend time fruitlessly evaluating which person or department moved too slowly when inherently, the whole process lacked efficiency and speed.
Similarly, loans categorized by the institution as Red should be either restructured in a way to improve the loan risk or declined quickly. Responding quickly to a prospective borrower where the institution sees no potential for making the loan is better than a “slow no” — a lengthy time period where the applicant is expecting or hoping for approval but eventually is denied. Investing excess time and resources in a traditional underwriting process for loans destined for declination is inefficient and increases the potential for compliance risk. In many institutions, weaker loan applications are either ignored or batted around the institution for excessive time periods without resolution or feedback to the borrower. This is obviously not in the best interests of the borrower or the institution. Further, many institutions have weak loan declination processes (or documentation of those processes), which can create both regulatory compliance and reputation risk. Finally, too many institutions work exhaustively on weaker loans trying to make the square peg fit in the round hole. This grossly inefficient process takes time and labor resources away from making loans that make money for the institution. When a loan is not bankable in its present state, an institution should make a speedy decision, respond to the borrower and move on.
Yellow loans, or those in between Green and Red, represent income opportunities into which institutions should invest time and labor in order to determine approval and declination decisions. These may have some identified credit weaknesses on initial review and may not be clear-cut approvals or denials. It is this Yellow loan category where bankers should focus their best lender and credit department resources to maximize earnings while managing risk.
Financial institutions seeking earnings and efficiency gains should look to their lending operations and consider adopting loan pathing to gain a strategic and financial advantage. By incorporating automation and workflow management to map the path of various loan applications based on their strength, financial institutions can focus resources on applications that warrant more analysis and evaluation so they can ensure any loan approvals will meet institutional risk and return objectives.
(To learn more about incorporating loan pathing into the loan decisioning process at your bank, Abrigo is offering a complimentary webinar on April 3, 2019.)
Neill LeCorgne is vice president of banking, Abrigo.