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European consumer finance: Moving to a “next normal”

For providers of consumer finance, there are crucial near-term moves and those that respond to likely longer-term shifts in customer behavior. Both are equally important.

Advises European financial institutions, focusing on strategy, retail distribution, consumer finance growth, and omnichannel solutions

Serves both universal banks and FinTechs across consumer Finance topics, and Co-leads McKinsey’s European Consumer Finance tribe

Serves banks across Europe mainly on retail as well as consumer and car finance topics

Expert in European financial services benchmarking, with a focus on consumer finance and retail distribution topics

The COVID-19 pandemic is foremost a near-term crisis in global public health. The economic effects, however, will also be profound. We now see rising unemployment, corporate failures, asset depreciation (and volatility), and high uncertainty.

In the near-term, we expect that European consumer finance will see massive disruption. Consumer confidence and consumption has been falling sharply and is expected to stay low for an extended period, leading to decreasing demand (Exhibit 1).

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Consumer spending is falling as consumers cut back on purchases that can be postponed (discretionary spending such as cars and appliances), and increasing precautionary saving due to the uncertainty of the trajectory of the health crisis. According with McKinsey’s Europe Consumer Pulse Survey 2020, consumers expect to reduce spending in almost all retail categories, with the exception of groceries and home entertainment (Exhibit 2).

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During their first-quarter 2020 results presentations, some European consumer finance entities reported new lending declines of between 40 and 70 percent year-on-year for the months of March and April. Point-of-sale financing, triggered by the online channel, appears to be declining less than credit cards and unsecured cash loans.

Moreover, unemployment and short-term work will at least provisionally rise, leading to pressure on customers’ ability to afford purchases and on their creditworthiness, while making risk-scoring more difficult. These trends could lead to reduced credit supply or a rise in non-performing loans and default rates, combined with higher pricing.

Beyond these various impacts, we expect lasting changes in consumer behavior. As customers turn towards remote and digital channels to avoid close physical proximity, we expect that many will continue their use of digital channels beyond the immediate crisis, and that retail e-commerce to grow significantly (Exhibit 3). In China, online shopping has increased by 15 to 20 percentage points, and e-commerce in Italy has increased by 81 percent compared with the last week of February. We also expect internet banking penetration to see a steep increase in most European countries.

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In contrast to the financial crisis, the reputation and trust in financial institutions are not at high risk. And if the industry successfully transforms itself to meet the needs of customers during a period of uncertainty, it could go a long way toward restoring the confidence of customers and society.

What consumer finance entities can do now

To begin, consumer finance entities need to ensure they have solid risk management capabilities. Adjusted credit underwriting guidelines combined with solid collections management are key to ensure a firm credit portfolio.

In back-book management, segmenting customers is crucial. Clearly identifying those “without financial problems,” those “(potentially) in need of support,” and those “in trouble.” For those in need of support, adjusting loan conditions will protect customers from imminent insolvency and prevent a rise in non-performing loans. For customers in trouble, consumer finance firms should take a caring approach, with measures such as the extension of loan maturities, or waiving fees on overdue loans (some European governments have imposed these actions). This is a crisis that is not self-inflicted. Consumer finance entities need to introduce “smart collections” to limit the damage.

Consumer finance entities can focus on a series of frontiers in order to increase their resilience and ensure readiness for the next cycle, when consumer default rates are likely to increase. They must be ready to use segmentation for targeted campaigns, adjust collection measures and proactively offer restructuring options, or installment breaks, before they become necessary. They also need to ensure high liquidity levels and capital ratios, should credit risk inflows start rising.

Operational excellence will require careful scenarios planning. A range of scenarios on consumer demand should be used to stress-test the top-line structures and develop cost mitigation strategies (e.g., operating expense programs). Likewise, consumer finance entities should seize this momentum to streamline their credit process, shifting from two- to five-day processes to instant decisions, for both existing and new customers, leveraging internal and external data. Credit processes should be designed to maintain stable levels of cost-to-income and cost-to-credit ratios.

Cross-selling of other financial products, like insurance protection, can help lenders spread risk. Likewise, debt consolidation products could also be an attractive and helpful product for customers struggling with debt.

How to adapt to the “next normal”

The COVID-19 crisis may accelerate shifts in consumer finance customer behavior—in areas such as channel usage or financial needs. Consumer finance providers will need to address this shift in a number of ways, including speeding the development digital and other remote channels and increasing customer education on the use of these new channels; developing new products to meet new needs; and offering segmented customer relationship management. Banking customer needs can be grouped into four different areas—each of which require attention (Exhibit 4).

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Notably, we expect migration to digital and remote channels to pick up momentum not only in markets where digital penetration still has plenty of room to grow (e.g., Southern Europe, Germany) but also in those that are more digitally mature (e.g., Sweden). For financial services providers, efficient and smooth digital distribution engine will be an element in the battle to retain and gain market share. As an example, we expect the digital channel to grow as the conduit for the sale of credit cards and personal loans by between nine and almost 40 percentage points compared to the previous year, depending on the region (Exhibit 5).

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Some consumer finance entities will find hard to create end-to-end instant digital processes at such short notice, due to a lack of digital investment in the past. For these companies, we expect contact centers to gain relevance.

Customer education is another important element, not just for boosting short-term usage of digital channels now, but for helping to make digital part of the new normal. Importantly, consumer finance entities can go beyond, helping their customers get the most out of digital channels—they can also educate their customers on other relevant implications such as fraud prevention or financial liquidity advisory in the context of COVID-19.

Customers will also need new products that meet their evolving needs. Contactless credit cards, for example, will likely gain prevalence, given that people may be wary of physical proximity to others for some time, as they are also convenient and European regulators may continue to incentivize their use. And given the likely growth of e-commerce, consumer finance entities might also consider forging partnerships with e-commerce retailers.

For Europe’s consumer finance segment, there are crucial near-term moves—such as adjusting credit decision rules and responding to government initiatives—and those that prepare for a post-COVID-19 environment, and longer-term shifts in customer behavior. Both are important as the world looks toward the next normal.