- September 26, 2017
- Posted by: Gururag Kalanidhi
- Category: Loans
Debt Collection System
Debt collection process involves pursuing payments of debts that have been owed by individuals or businesses. Debt collection has been prevalent since the early days of banking as it is the chief source of income for banks.
This is an important part of the loan industry and organizations that specialize in debt collection are known as Debt collectors or Collection Agencies. Most collection agencies operate as agents of creditors and collect debts for a fee or percentage of the total amount owed.
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Traditional Collection Methods
Loan collection is usually a process which is highly regulated. As the creditor wants to get back the loan with its interest, they usually offer the loan with either a mortgage or a guarantor to back the debtor. The debtor enters into a legal agreement with the lender to repay the loan by a particular time and date.
This is monitored by both the creditor and the rating agencies to track how prompt a debtor is in repaying the loan. This is used to calculate the credit score of a debtor for future loans.
Generally, the method to collect a loan follows the steps given below:
- Collect the money coinciding with the arrival of the debtor’s income cycle
- Maintain a systematic follow-up on how the customer can handle the repayment
- If the customer shows discrepancies in one or two installments, reach out to the customer to find out the cause.
- If the customer is prompt, preserve goodwill and promote more offers to him.
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When it comes to collecting back the loan, banks usually two methods of collection. As loans are paid back to EMIs, the banks do not intervene or disturb a customer if the payment is prompt and on time. They maintain a cordial relation with the debtor and accord them with further credit proposals if the client exhibits discipline in the repayment process.
However, not all debtors can pay back on time. Owing to various reasons, they may default on the payment of their owed capital. Such defaulters are usually provided with several opportunities to pay back their owed sum.
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Following methods are usually undertaken to ensure that the debtor is legally requested to fulfill his commitment:
- The bank will send a ‘letter of demand’ to the debtor on its letterhead, demanding that the debt is paid by a particular date or legal action may be taken.
- Secondly, they may issue a ‘final’ letter of demand
- Several banks also contact their clients via phone to get them on record to find out the reason for their potential defaulting.
When none of the aforementioned steps bear fruit, the bank usually writes off a loan and tries to adopt one of two steps to recoup whatever it can on the defaulted payment. While mortgaged properties may be auctioned off, on loans that do not have a collateral, the banks usually enlist the services of a collection agency.
After this, the bank usually hands over the responsibility of collecting the debt to either the First-Party Agency or a Third-Party Agency.
First – Party Collection Agency:
For the first six months of delinquency, debtors deal with a First-Party collection agency. This is usually the creditor’s internal collector. The debtor, in this case, is the second party. This may be an ideal time for the debtor to settle your debt as no middlemen are involved, and the credit scores of the borrower will remain good.
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Third – Party Collection Agency:
When the first step does not bear fruit, the lender may usually assign the debt to a third-party agency. This is usually a specialized loan collection agency. At this point, the debt is still owned by, and owed to, the original creditor.
If the third-party agency is successful in recovering all or part of the debt, they will earn a commission from the creditor, usually a fee, or a percentage of the total amount owed. They are separate companies contracted by the creditors to collect debts on their behalf for a fee.
Problems in Traditional Collection Process
- Debt collection process is increasingly focused upon by regulators and is heavily scrutinized by regulatory bodies who have laid down several stipulations for traders to follow.
- Since the current debt collection systems involve several legally mandated processes and involve multiple layers of handling, they involve a huge amount of manpower to maintain records and involve several repetitive functions with very little integration between them.
- Debt collection agencies do not segment the customers efficiently. As these processes have been handed down for decades, the processes do not account for the change in the mindset of creditors and their earning patterns.
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- Segmentation of customers based on their income bracket is still inefficient. Collection agencies do not dedicate resources to analyze a customer and his income bucket. They have a broad category where they tend to bring all defaulters under the same umbrella.
- Some defaulters are capable of paying back their loans if they are motivated appropriately and offered extended assistance. Since collectors are not provided with appropriate tools to accurately analyze borrowers, they are unable to provide flexible payment arrangements.
- Collectors currently do not have right tools at their disposal to maintain borrowers as customers.
- There has been a lack of a consolidated borrower-centric approach, and the system makes it increasingly difficult for debtors to get out of the interest trap. The current system does not allow collectors to recover piecemeal segments of the owed money from customers.
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Issues faced by NBFCs and MFIs
When it comes to loan collections and recovery, NBFCs (Non-Banking Financial Companies) and MFIs (Micro Financing Institutions) face far greater hurdles than banks themselves.
- Impoverished customer base:
Given the fact that both these organizations operate in the unorganized labour sector where they cater to low income and BoP class of borrowers such as farmers and daily-wage labourers, the likelihood of their customers defaulting on payment is far higher than in the organized sector.
- Increasing burden of regulations:
As these organizations increasingly come under the purview of regulatory authorities, the process of collection comes under scrutiny and they face issues with respect to following the tough guidelines that have been imposed on by central banks.
- Less flexibility in the collection process:
Most of the customers who avail loans from these institutions are not tech-savvy and do not have access to well functioning bank accounts. Hence, most of their transaction has not been made digital and they do not get the flexibility of paying through small installments.
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Modern Collection Process
Where traditional collection processes have faltered, the techniques and practices adopted as a part of the modern collection management systems have gone a long way to address several pain points that were encountered in the earlier systems.
The modern collection process follows several guidelines that aimed at streamlining the operations and offer benefits to both collectors and their debtors. Augmenting the robustness of the internet networks and a centralized financial system, the following aspects of the modern collection management software go a long way in the ease of business:
- Auto-generation of Customer Statements: Customer statements and payment notifications are sent to customers via a comfortable mediums such as SMS and emails. This is usually coupled with an UPI payment option where customers get the luxury of paying their debt using their credit or debit cards and thereby circumvent a trip to the bank or the loan agency.
- Digitized Collection Strategies: By using analytics, software can now automatically flag and score delinquencies based on factors such as amount due, aging, percentage outstanding and credit limit. This can help with a more well-rounded and efficient segregation of customers.
- Managing Collection Activities: Once the segregation of customers is done, the database can be used to personalize the collection strategy for each customer or a category. This can be followed up with relevant course of actions such as friendly reminders, phone calls, periodic dunning, etc. All of this is now tracked on a dashboard where each customer gets a separate folder and all interactions with the customer are maintained with transparency.
- Managing Settlements: The modern collection system also allows initiation of disputes on behalf of the customer for review and helps receive approval within and across departments. It streamlines the process of grievance redressal and improves customer goodwill.
- Optimize Collection Efficiency: The modern collection management softwares optimize the collection activity by ensuring that specialized retrieval offers are assigned to cases that require their expertise. They can also monitor outstanding receivables.
- Analyzing the collection team: Softwares allow senior officers to manage collection team assignment based on performance metrics and key performance indicators (KPIs). The softwares are also programmed to automatically assign new account delinquencies to agents.
Advantages of Modern Collection Process
- The modern collection processes aim to address the entire loan collection process at its core issues by bringing automation and digitization to the fore and streamlining the process.
- The effectiveness of a system, or “Collection Performance”, is a by-product of the quality and accuracy of information provided by the collection management software.
- By digitizing the entire process, the need for a manual system to keep loan balances, payment due dates, notes and other relevant information is greatly diminished and reduces the inefficiency in the process.
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How can technology redefines the traditional process
Technology has a crucial role to play in weeding out the inefficiencies in loan collection process that is not just beneficial for the lender, but also for the client.
- Reduced processing time by optimising work distribution
- Automatic identification of bottlenecks and deviation in a short time frame
- Better recovery through automated allotment of clients
- Garnering maximum information on a customer and identifying the most comfortable way to retrieve the loan.
- Reduction in errors through minimized manual entries
- Better compliance with regulatory requirements
- Reduced turnaround and processing times
- More flexibility in payment options
Technology has changed several industries and brought efficiencies to the existing processes. The field of loan collection badly requires innovations in order to improve collection efficiency and recover bad loans. Leveraging the power of technology, credit lending institutions look to adopt methodologies that are effective in helping them offer better deals to the debtors and help them recover loans without any hassle and maintain goodwill with the customer.