As long as there are no adequate statistics on consumer credit, there is no sense in insuring them. Even more so when such statistics finally do appear.

Yana Galukhina, Yury Korotetsky and Maxim Rubchenko

The consumer lending boom is expanding in Russia. Credit sales of household appliances, furniture, and cars seemed impossible in Russia as recently as three years ago. Today, they are common and steadily increasing. Specialists at ROSNO Insurance estimate that as of January 1, 2004, Russian banks lent out 300 billion rubles in purpose loans to individuals to purchase a variety of goods, and by the end of the year, consumer credit will exceed 500 billion rubles. Thus, as the trend is evident, it would be silly not to try and make money off of it, even if your business has nothing to do with credit or retail trade but deals only with insurance.

Keep off our turf

It should be noted that experiments with credit insurance have already been conducted in Russia, and they left both bankers and insurers with bitter memories. “Before the 1998 default, credit risk insurance was widespread, since insurance legislation allowed companies to do it at the time,” says Lyudmila Markina, Director of the Risk Department at the Bank of Moscow. “At that time, everybody was anxious to make money: insurance companies received income from insurance premiums, and banks issued loans in volume. As a result, insurance companies incurred heavy losses, as banks lent out loans indiscriminately – they thought insurers would pay claims for defaults.” When the financial crisis broke out, banks began to call in the issued loans and after they had realized that they lost their funds, they began to make claims on insurers. As a result, a lot of banks and insurance companies went bust, and the Russian financial market fell into a coma. While banks have overcome the consequences of the crisis over the last 2-3 years, the insurance market began to revive only after the authorities had presented them the extravagant gift of compulsory third party liability auto insurance. The sad experience of the past convinced bankers that insurers should not set foot in their business at all. Therefore, most bankers are willing to allow only their affiliated insurance companies to engage in credit insurance. “It’s difficult for me to evaluate how successful ROSNO’s new initiatives will be,” says Markina. “Our experience shows that insurance companies should not attempt to evaluate a borrower’s creditworthiness –banks do it better, since they possess both special methods and trained staff. Otherwise, the bank would have to evaluate the risks of the insurance company itself – whether it would have enough funds to indemnify a bank for losses in the event of mass default. The insurance company must be very reliable, and the most reliable company is the most transparent and most comprehensible – as a rule, that means it’s a company related to the bank.”

Inscrutable risks

The fact that ROSNO intends to insure consumer credit by no means adds to the enthusiasm of their counterparts from other companies.  “Consumer credit insurance is not widespread worldwide,” says Viktor Klimov. “The reason for this is that the very essence of credit insurance is a forecast of debtors’ future financial standing. So, this is a product of a very developed market when there is already capacity to forecast the situation with confidence. The second condition is that there must be good legislation on bankruptcy. In Russia, there is simply no law on bankruptcy of individuals.”
Banking community representatives call into question the very capacity to evaluate consumer credit risks adequately. ROSNO’s representatives explain that modern methods are supposed to solve this problem. “Our product is based on an automated scoring system, the system of a borrower’s credit evaluation. We have developed it taking specifics of the Russian market into account,” explains Yury Klein. “Using this system, we are able to evaluate a borrower’s creditworthiness ourselves. It’s an fast evaluation that takes 10-15 minutes, at most, and it is realized via a remote access system.”
Insurers are confident that having assumed the responsibility for evaluating borrowers’ risks, they will help banks reduce their business costs significantly. “To launch a consumer credit project, a bank has to rapidly evaluate a borrower’s creditworthiness via a remote access system. Naturally, the bank needs to invest money to either develop this system or to buy it,” Yury Klein argues.  “In addition, it needs to set up points of sale in retail outlets and place banking staff there, which is costly. We enable a bank to minimize these costs: we install appropriate software and train banking personnel ourselves. This is of interest, first of all, to those banks that are about to enter the consumer credit market”.
Defaulters are a problem of no less importance that insurers are ready to address. “The bank, that has decided to deal with consumer credit, should create a means of settling default claims,” says Klein. “To this end, the bank, first, should have people to handle problem customers. Secondly, all problems are settled through court – there is no alternative in Russia and this is a lengthy and expensive procedure. When insuring credit, we assume settlement of defaults: when an insured event occurs, we pay compensation to the bank and afterwards start dealing with the individual.”

A service for three

According to ROSNO, three large Russian banks – Gazprombank, Menatep St Petersburg and DeltaBank – have already shown interest in the new service. “We have our own scoring technology in place. Nevertheless, we have come to the conclusion that we need insurance against defaults on credit,” says Dmitry Ishchenko, a DeltaBank board member. “Therefore, we have started a pilot project with ROSNO on our risks insurance. This insurance is designed to solve the problem of reducing credit cost. Every loan costs a bank something: it needs to spend money on purchasing and fine-tuning scoring software and on monitoring loans. Handling debts – with the involvement of legal advisers and call center operations– is expensive. The reserving system costs quite a lot. Insurance can reduce costs. For example, we have insured credits and we would not need our own section to handle debts.”
For a start, DeltaBank has insured about 500 consumer loans with ROSNO. Both companies evaluate credit risks in parallel: the bank’s specialists evaluate credit risk using its own technology, while ROSNO’s specialists use their scoring system. Having evaluated the risk, ROSNO informs the bank whether it is ready to insure a loan to this particular borrower. According to DeltaBank representatives, their cooperation with ROSNO is developing successfully for the time being but it is too early to draw final conclusions, and a reduction in interest rates on consumer credit is currently out of the question altogether.

Field tests

ROSNO never assumed that the banking community would welcome its new service with enthusiasm. Therefore, insurers intend to focus on another category of potential customers – retailers. “While bankers understand what credit risks are and already have ways to evaluate them, there is nothing of this kind in retail, because it’s an absolutely different business. Retailers would be happy to shift these risks onto insurers’ shoulders,” says Klein.
However, experts are skeptical about the prospects for credit insurance in this area as well. “The probability of losses can be calculated mathematically,” says Maxim Chumachenko, Deputy General Director of the Rossiya Open Insurance Joint Stock Society. “Let’s assume that there will be one bad customer per every thousand buying on credit. However, the retailer will be able to make good on these losses easily from funds it collects and this will not affect it at all. I think that a normal retailer’s turnover is approaching a billion dollars a year and one can be confident that they always have enough liquid funds to cover a large percentage of defaults. And $50,000 in unreturned loans a year is nothing for a bank. It’s even not a mosquito bite. So, why should the bank insure and give somebody a premium?”
It seems that the only goal currently pursued by ROSNO, by banks that have joined the program of consumer credits insurance, and by retailers that will join this program in future is to develop statistics and methods for evaluating consumer credit risk. When this goal is achieved, banks will adjust their interest rates on credit to the optimum level, and retailers will reserve funds to compensate for defaults. As for insurers, while they will be able to offer customers adequate rates for insuring consumer credit, it is doubtful that there will be a great demand for this service. 
 
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