Defending against a recession: Proactively managing portfolios using AI, alternative data

Although nobody wants to dwell on negativity, especially where the economy is concerned, it is also said that luck favors the prepared. For this reason, lenders might want to be proactive to prepare for a potential recession. As an industry, we’ve faced recent challenges both through the pandemic and the subsequent inventory shortage and have come out the other side resilient. This has been accomplished in part through the intelligent use of automation and artificial intelligence (AI) technology that strengthen laborious workflows and allow lenders to become more efficient.  

The most practical difference between lending during a healthy economy versus a tight one is that lenders must pay more attention to the bottom line. When the economy is booming, there’s more room to compensate for fraud attempts or intentional defaults, since profits are more robust. But when the economy has slowed and it impacts receivables and cashflow, mitigating fraud becomes more essential. 

Fighting synthetic fraud: Why it’s more crucial in a soft economy 

Lenders need to become more vigilant to deflect a rapidly growing problem: synthetic fraud. These instances can cause great damage to financing companies, especially to the smaller company that provides in-house financing and may have fewer resources than a larger institution.  

In a nutshell, synthetic fraud is when a nefarious actor creates a fictitious applicant persona based on aggregating actual datapoints, building a profile that looks real and valid to a lender. For example, these bad actors will construct a profile using a social security number from one person, an address from another and a job history from yet a third person and transform it into a fictitious customer profile that is more difficult for traditional online systems to pinpoint as false. Once these malicious actors secure financing and the vehicle, that car or truck is quickly sold on the black market and shipped out of country, and then the fabricated applicant disappears.  

Synthetic fraud is not new; it’s been an issue in the finance industry for years. However, the problem has become more prominent in the automotive sector over the last two years. Recent estimates claim that synthetic fraud incidents have increased by more than 200%, according to risk management platform Point Predictive. It can be more challenging to combat this threat in automotive lending, since the industry can be siloed, and information between dealers, lenders, leasing companies, credit unions and other institutions is less often shared. This makes it harder to comprehensively address fraud. 

To combat this, providers can turn to new technology such as predictive scoring solutions, which leverage data from a consortium of auto lenders to better identify fraud. Companies like Point Predictive are at the forefront of these innovations. Loan origination systems (LOS) and loan management systems (LMS) should incorporate these types of solutions, which use sophisticated AI to gather alternative data from a host of online sources to validate actual applicants or expose synthetic profiles.  

Leveraging alternative data for proactive portfolio review 

Another area of legitimate concern is that consumers often come upon hardships like job loss or income reduction during a soft economy. Lenders should look for ways to lean on automation, AI and customized LOS or LMS solutions to help better prepare for an economic downturn. Emerging sources of alternative data help lenders better predict whether to approve a set of applicants based on a deeper risk assessment. Alternative data also helps lenders manage their existing portfolios throughout the life of those loans, even if uncertain circumstances impact their customers’ income levels.  

For example, regular batched portfolio reviews can be used to identify changes in credit risk. An effective LMS will use alternative data sources to indicate whether a borrower has been let go, has filed for unemployment or otherwise shown an income drop or a change in their ability to pay their bills. 

The LMS will automatically flag the account and alert the lender to these developments, allowing the loan manager to proactively reach out to the consumer and renegotiate a payment schedule or provide other options to prevent a loss. Automated tools give lenders enough preparation and visibility into potential risk to both safeguard the loan and help the customer maintain their credit rating, even through difficult financial straits.  

In addition, there are other alternative data providers to further mitigate risk. Equifax’s income verification service receives weekly updates from millions of U.S. payroll providers. This massive amount of data can be ingested into the Inovatec LMS, for example, where it is used as another loan portfolio management tool to give lenders visibility into accounts that can be at risk due to a change in employment. This enables lenders to take the necessary steps to thwart any negative threat to cashflow and the portfolio at large.  

When the economy is volatile, there’s no debate — our industry becomes more vulnerable. Lenders that properly prepare and leverage sophisticated alternative data sources, AI capabilities and other innovations have a far better chance to weather any economic downturn.  

Vlad Kovacevic is the founder and CTO of Inovatec Systems. Inovatec provides LOS, LMS and direct systems that seek to eliminate friction in the lending process and automate the manual work of originating and managing loans.  

Auto Finance Summit, the premier industry event for auto lending and leasing, returns October 26-28 at the Wynn Las Vegas. To learn more about the 2022 event and register, visit www.AutoFinanceSummit.com.