Leading up to and through The Great Recession, I had a front row seat for what was a very wild ride. I had responsibilities that included pricing and credit policy for subprime mortgage and home equity lending at a large institution that kept most of these loans in its portfolio rather than selling them off to investors. As such, we had a huge amount on the line as the situation unfolded and we could not sit idly by as new information came in every week or two that influenced our expectations about loan performance.

That was over a decade ago now, and a lot has changed about banking and lending. After such a long period of benign economic conditions, the industry is now looking at the possibility of another downturn. As I write this, the stock market just completed its worst week since, you guessed it, 2008. The trade-related stresses already present in international markets compounded by the virus-driven threat to supply chains and risk of large-scale quarantines, have put the US economy at risk of falling into recession.

Recessions and Lending

What does this situation mean for consumer and small business lenders in the US? It is highly unlikely that we will see a repeat of the Great Recession of 2008, particularly in how it impacts lenders. A lot has changed. Capital cushions at banks are now much higher, which has generally resulted in less aggressive lending practices. Housing credit, the largest loan category by far, is much healthier, without the unsustainable products and underwriting of 15 years ago, and with generally healthy, not overinflated, home prices.

All that said, recessions can be particularly challenging for lenders because many dynamics typically move quickly and simultaneously. Unemployment rises, customer incomes become less certain, and collateral values fall, resulting in higher delinquencies and charge-offs. At the same time, lender strategies can be complicated by more competition for collections capacity and customer payments while customer borrowing demand goes up and competition for new borrowers goes down.

Every Recession Is Different

It is tempting to focus on the lessons from that last recession in preparing for the next one. While that is not a bad practice, it is important to remember that every recession is unique and will hit each lender differently. For example, depending on how the recession hits various asset classes, customer segments, and geographic areas, each lender’s portfolio mix will result in a different experience. There are many new dynamics in the market too that will undoubtedly influence how the recession impacts lenders. Some examples of possibly important new factors include:

How will student loan debt being a much larger portion of consumers’ debt loads affect performance?
How vulnerable is auto lending due to high car prices and aggressive competition, among other factors
How will new technologies such as ride share (impact on auto lending), smartphones (top of the payment hierarchy now), and gig economy (volatility of income) affect loan performance?
How will different geographies and business types be affected by increased global interconnectedness?
How will the proliferation of non-bank finance companies with vulnerable funding sources affect the customer segments that disproportionately rely on them for financing?

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It is important to remember that every recession is unique and will hit each lender differently
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While all of this may make it seem like too complex a problem to effectively prepare for, this is not the case. Lender strategies, nimbleness, and preparation all significantly impact how well institutions survive during, and thrive after, a recession.

Common Organizational Hurdles

Lending organizations frequently face similar obstacles as recessions unfold. Recognizing and diagnosing the nature of the stress and getting aligned quickly as an organization on how to make decisions are key initial challenges. When it then comes to action, many institutions cut costs where key capabilities are needed and/or make draconian or misplaced product or policy changes that hinder the ability to quickly return to a healthy business as the recession winds down. Most of these issues can be mitigated substantially with thoughtful, and timely, preparation.

Downturn Playbook

So how best can lenders get prepared? First and foremost, they must develop a downturn playbook that says what actions to take and when, tied to certain monitoring triggers. Developing these plans in advance, when thoughtful assessment is more possible than in the teeth of a downturn, is key. In addition, it allows time for the organization to come to agreement about strategies ahead of time, which enables more nimble responses. What are the elements of a good downturn playbook? A few of the most important are:

Identify and prioritize critical capabilities that require investment
Prioritize and develop tactics across all portfolio and customer segments. These tactics should cut across all stages of the customer life cycle, including acquisitions, customer management, and collections
Ensure monitoring is timely and focused on key triggers and portfolio vulnerabilities to enable the organization to react quickly and accurately
Ensure loss forecasting models are nimble and accurate enough to quickly and confidently help leaders better understand the situation and make decisions

Leading institutions have already done the planning, made the investments, and aligned their teams on how to manage and be responsive through the next downturn. Many lenders have great teams running their businesses and minding risk. However, with many competing organizational priorities, taking the time to prepare for a downturn is easy to put off. Bringing in outside perspectives, comparative benchmarks, and incremental skills focused on preparations can be a quick boost to getting ready ahead of a more dynamic environment. Preparing for the next downturn is a critical investment of time and attention for every lender that cannot wait until a downturn starts. The time is now.

The Time is Now to Prepare for the Next Downturn

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