The impact of collections strategy on the profitability of unsecured bank microloans

Abstract

There has been little empirical work on how collections strategy can be used to maximise profits. The aim of this research was to investigate the impact that one particular collections strategy, called behaviour based collections, had on the costs, revenues and eventual collections outcome of defaulted microloans. This is one of the few studies on the collections function, and perhaps the first to investigate this aspect of collections strategy.Microloan books from different business units were analysed and compared. One business used a behaviour based strategy to collect on arrears, in which a client was expected to establish regular payment behaviour before repaying the arrears amount. The other used an arrears based strategy, where the client was expected to repay missed instalments immediately. Measurements of cash flow, eventual collections outcome, costs and change in credit risk were taken from each sample and tested using Mann-Whitney U tests and chi-square tests. The results show that the eventual collections outcome (whether the defaulted loan is rehabilitated or written off) does not vary according to collections strategy. For both strategies, as credit risk worsens, there is a decrease in revenue received; as credit risk improves, revenue received rises. In contrast to industry best practice, the research finds that behaviour based collections results in 3.37% more revenue when the loan is rehabilitated, and a 4.54% reduction in losses when the loan is written off. The research also finds that the cost of using a behaviour based collections strategy is lower than using an arrears based strategy. These results suggest that the collections industry can realise significant gains from the application of behaviour based collections.