Merchant Acquiring Lessons Learned from the 2008 Mortgage Crisis
August 22, 2016
Much ink has been spilled about the 2008 Mortgage Crisis. In the U.S, $10 billion dollars worth of subprime mortgages dealt out by Mortgage Companies that were not prepared to assume the risks, inevitably found themselves into a race to the bottom when investor debt turned grotesque. How did this happen and what was the root cause? The answer, was a problem in underwriting processes.
Leading companies found initial success by implementing a risk model that incorporated industry assumptions into their onboarding process. The assumption was that 20% of the client base would inflate their income level by 20%. By doing so, companies significantly reduced the amount of work required to approve a new client. But what happens when client behaviour changes? Eventually, half of new clients were inflating their income by 90%, taking heavy advantage of risk assumptions that continued to remain at a 20% income level inflation. If you were claiming to have $100,000, the system would adjust your income to $80,000, when in reality you only have $10,000. On a large enough scale, that’s a recipe for disaster.
There are major lessons for Merchant Acquirers to learn from the underwriting nightmare that was the 2008 Mortgage crisis. In the U.S., key mortgage players were pushing the competition to underwrite faster in order to keep up with onboarding new clients. The same thing is happening today in payments with the likes of Square, PayPal, Intuit, etc. Merchant Acquirers need a clear strategy to be able to win the onboarding race without burning out. If Acquirers aren’t careful, they will either be left behind in the onboarding race or fall into the same underwriting traps that occurred in 2008.
Here are three key learnings that Merchant Acquirers can take away to improve their onboarding process:
1. Create a “minimum viable process” in underwriting.
Your underwriting process is the oversized mountain between Vancouver and Whistler, and you will simply never have an excellent onboarding process until you start blasting away at that rock. The very first step in creating a faster, more delightful, cost-efficient onboarding process, is to design a Minimum Viable Underwriting Process. If you’ve never heard that term before, it’s because we made it up. Here’s our definition of Minimum Viable Process: Doing the least possible work to achieve the most effective result.
This applies to:
- Asking the merchant only the most essential questions
- Completing only the most necessary data checks
- Using the fewest possible number of systems to house and manage merchant data
- Having the least number of “middlemen” necessary
The first step in executing a Minimum Viable Process is blasting as much “rock” out of your onboarding and underwriting process as you can. In other words, you remove as many steps as possible from both the merchant sied and the back-office side. Your underwriting process has many steps that likely do not add significant value. Working backwards from underwriting to client onboarding, make a list of all the potential inefficiencies.
2. Avoid the “More Data” Trap
Many organizations make the mistake of thinking that they are better protected by collecting more information and analyzing more factors. This simply isn’t true and, in fact, extraneous data points just result in you incorrectly turning away good opportunities.
Here’s what we mean:
Some data services communicate the same information as other services in an overlapping way. For example, a customer may make a complaint with the Better Business Bureau, and then write about it on Yelp. If you’re collecting both of these data points, you’re artificially increasing the merchant risk by analyzing overlapping data. In statistics, this is called a “Specification Error”.
This is another opportunity for you to blast some rock. Choose the 1-2 data points you believe are the most relevant for each category. Double-check that they are not overlapping data sources (for example, Yelp and Better Business Bureau). Then, move forward confidently knowing you’re avoiding the “Specification Error” of viewing the same piece of negative data from two different sources.
3. Automate your underwriting so that your underwriters can analyze.
Once you blast out all of the rock, configure your underwriting systems so that your analysts don’t have to do any data entry or calculations. Underwriting should be looking at the next stage, resolving “fuzzy matches”, completing complex determinations, and arbitrating borderline decisions. Having a numerical risk score is essential. It is imperative that underwriters are able to not only pass, fail, and pend applications, but be able to identify how an application passed or failed. If you do not do this, you will never be able to intelligently use underwriting data to make smarter business decisions. Underwriting, when well executed with automated processes and thoughtful human analysts, can be turned into a strategic business asset, rather than a cost center.
History is doomed to repeat itself if we don’t learn from it. While the parallels between mortgage lending and merchant acquiring are not exact, we know for sure that cutting risk and underwriting corners always ends in disaster, and that failing to execute a fast sign-up process means stunted revenue growth through frustrated customers. Merchant acquirers can solve both of these problems through a robust, automated onboarding and underwriting process.