Using analytics to mitigate risk during a recession

The number one question we’re receiving from financial institutions today: How can we recession-proof our business?

While no playbook exists for FIs to reduce risk during a recession, gaining the right insights to better inform credit decisions, mitigate fraud and optimize compliance workflows is a solid start. Anticipating changes through trends monitoring and analytics can help institutions formulate a plan.

Our analytics team reports that credit quality has decreased over the past three months across millennial and Gen Z populations as these groups seek short-term loans to cover the increasing costs of living. We’ve seen a 44% increase in short-term loan applications for millennials and a 66% increase for Gen Z.

Are all millennial and Gen Z consumers a risk? No, but lenders need a complete picture of each consumer beyond traditional credit scoring. Important items not in traditional credit reports, like payday lending or buy now, pay later transactions, can serve as an endorsement or a canary in the coal mine when it comes to approving applicants.

Analytics tools that employ advanced algorithms and machine learning (ML) can deliver insights to assess loan risk more effectively and mitigate repayment default. These insights are even more vital during a recession.

Combine historic information with alternative data

FIs should keep in mind that federal student loan forbearance has ended – the federal government is preparing for loan payments to resume in September. If or when a recession hits, customer behavior will surely change as people look to reduce spending. Having an additional loan payment can further stress budgets.

Other insights of value reside in credit scoring. Our team noted a decline in credit scores for renters and younger consumers the last several months. How will FIs know if these consumers are worthy of the short-term loans they’re seeking?

Alternative data insights fill the gaps for consumers with thinner files. Our recent Alternative Data Impact Report found at least two-thirds of FIs surveyed use alternative data – a variety of non-credit events that include asset profile and information like education, personal property ownership and professional licenses – in credit-risk assessments for underwriting and portfolio management. Even more institutions use alternative insights in prescreening and credit risk across the customer lifecycle, with credit unions taking the lead.

Enhanced fraud prevention

According to our latest Cybercrime Report, digital fraud rose significantly in 2022, with the global attack rate up 20% globally for all sectors.

Fraudsters tend to follow trends, which they did during the pandemic by targeting increasing mobile transactions. There was an 8% increase in 2022 for desktop transaction attacks compared to a 37% increase in mobile browser and 58% increase in mobile application attacks.

Fraudsters will no doubt try to capitalize on economic uncertainty. Optimally, FIs should participate in a consortium to share digital insights with other FIs. Fraudsters tend to operate in a network and FIs should fight fraud the same way.

Improved compliance ahead of a recession

As businesses struggle during a recession, there is often increased competition for a shrinking pool of resources. This can lead some businesses to gain an advantage over their competitors by engaging in criminal activities, such as embezzlement, Ponzi schemes or insider trading.

FIs should be vigilant, take appropriate measures to prevent and detect financial crime and prepare for the possibility of regulatory challenges, particularly if they operate across borders, as regulators could increase scrutiny to prevent systemic risks from spreading throughout a financial system. Alternately, government agencies may be forced to cut back on funding and staff during a recession, which can lead to crime going undetected and unpunished.

Regulators will want to maintain programs this year that address persistent international issues including terrorism. Although Russia-related sanctions have slowed since its 2022 peak when sanctions list were updated 329 times with 5,674 new designations, FIs need insights and screening tools now more than ever that enable compliance teams to easily adapt to fast changes, quickly remediate alerts and show proof of compliance.

Recession-proofing is not easy, but FIs can reduce their risk exposure by using historical trends, analytics and insights for better risk and credit decisioning, fraud prevention and compliance.

Grayson Clarke is senior vice president of market strategy at LexisNexis Risk Solutions.