A New Class Act?

Risk based lending (RBL) was introduced to credit unions in the mid 1990’s.  Many credit unions now use this approach in some or all  of their lending offerings.

The debate continues as to whether this is consistent with coop principles.  Here is one CEO’s view.

(from Jim Blaine)

Balanced lending…

Many, many credit unions have successfully implemented risk-based lending to the benefit of each and every member. More and more members are calling out and demanding increased risk-based lending by credit unions. Never has one concept been so uniformly and enthusiastically accepted by the masses. RBL is the top requested service on every member survey – right?.

One CEO told me that RBL was an easy sale to the Board after one Board member got back from an RBL seminar cruise. Evidently, in the bar, the Board member was chastised by an RBL advocate with the arguments: “You mean you charge the same loan rate to an admiral as you do to an E-4? You mean your school superintendent pays the same rate as the first year teacher?  The blue collars get the same deal?! Do your maid and gardener get the same rate you do?  That’s not fair! You’ve got to start running that credit union like a business these days!”  

It’s an especially easy sale, when you lace the poison with a few high heat words like unfairness, subsidy, unprofitable, freeloading – free riders. Fairness, of course, is something every credit union person supports. Every effort should be made to assure fairness is a fundamental, core value of the credit union philosophy.

Evidently for the first seventy or eighty years of the credit union movement, boards and members didn’t care much about fairness in lending. Unfairness existed in all credit unions since none used risk-based lending….

Secret formula…

Critics try to make an issue out of the “unfairness” in RBL. They always want to claim that while RBL may achieve consistency in credit union lending decisions, RBL was never designed to achieve fairness. With RBL, members are divided into risk “classes” (A,B,C,D,E, etc.) based on a secret formula of risk criteria.  

Although the secret formula for risk criteria isn’t advanced enough to tell us which exact member will default, it is explicitly accurate in knowing which “class” to which you and I should belong. There are no shades of gray in an empirical, statistical model. Don’t tell me about the divorce, the flood, the death in the family, or the reporting error. Your statistical record speaks for itself. The secret formula knows who you really are in your heart of hearts.    Cut the whining, pay the rate; fair is fair!

Complainers also don’t seem to appreciate the need to eliminate the subsidies within a credit union to “low class” borrowers. The financial stability of the wealthy few is being imperiled by the working class majority. If the poor can’t pay their loans, logically they should be charged a higher rate. 

A New Class Act?

But we haven’t even begun to fully exploit the benefits of risk-based pricing for the membership. Hope we can use the secret formula to help make some of the other operations of the credit union fairer. We’re already getting behind on the innovations being implemented by our guiding lights over in the banking industry.

Some local banks have used secret formulas to determine even more precisely which customers are profitable and which are unprofitable. Who wants an unprofitable customer? And there certainly isn’t any difference between an unprofitable customer and an unprofitable member, is there? Hey, credit unions aren’t welfare states, are we?

Those creative banks have started coding customers into green, yellow, and red “classes” at the call centers. Regardless of how long you’ve been waiting, green goes to the head of the queue. Greens have separate, fast teller lines and receive special services. Bright, bright greens can even receive “private banking” services so they never have to rub elbows with “the riffraff”. Don’t we want to serve our “best” members, too?

Whose credit union is it anyway?

Serving the members based on the distinction of “class” will go a long way toward increasing a sense of fairness and building unity within the credit union. We certainly haven’t been “a class act” in the past but surely everyone agrees that – in a cooperative – some members are more equal than others.

2 Replies to “A New Class Act?”

  1. Chip,

    Thanks for the offer to write an article in response: there were few “facts” in Jim Blaine’s piece to support his view. His implication—unsupported by a single fact—is that RBL is simply about grouping into social classes. It is not. It is about a track record of who pays on a timely basis and who does not, and who creates costs for the credit union and who does not.

    Who pays for the cost of delinquencies and going after people who do not pay bills? Should all members share in this equally? I have a FICO score over 840 and I do not want to be paying for the collection fees for someone who defaults consistently on their car loans. Those costs should be covered by those most likely to create the cost. Should an auto insurance company charge a reckless driver who is frequently getting into auto wrecks the same rate as a good driver who has a perfect driving record? As a good driver, should I being paying more to subsidize the reckless driver so that the insurance company can stay in business? Is this not risk-based pricing?

    This debate is not about “facts”–it is about a decision on fairness. Should responsible members subsidize the cost of membership of irresponsible members? For those who say “yes”, perhaps SECU is the CU to join. For me, I want a credit union that recognizes me as an individual, and the risk/reward tradeoff that my personal membership brings to the organization.

  2. Hey Doug, how about a very public discussion on this blog about your views and the “facts” of RBL? Certainly can’t hurt to seek the truth, can it?

    Well, what say Mr. Webster? Deliberate or just continue to pontificate?

    More precisely, put up or shut up!


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