Monzo's Approach To Credit Scoring
FCA acts to improve competition in the current account market
It seems to me that in order to answer that question fully, you need to know how much money you need to make on average per customer in order for the whole bank to be viable.
It should also be noted that given one of Monzo’s main selling points is the budgeting tools it offers, it may well be that your customers actually require overdraft services less often.
I suspect that given Monzo is only planning to make money through this method, then the basic percentage will actually be pretty high when compared to high street rates. However, given the bank is based on the idea of honestly and openness, then personally I would prefer a plain, honest rate of interest, with perhaps a couple of example calculations thrown in so no-one is confused.
As for deciding how much to offer customers, I think that credit rating agencies exact somewhat of a tyranny over many people, and force them to the more shady end of the market in order to find £50 to cover food until the end of the month.
I would much prefer Monzo to base decisions on things like average account turnover and previous customer behaviour rather than third party agencies.
I remember reading a long time ago when I started following Monzo about its lower costs than traditional banks, presumably allowing you to undercut other banks if you wanted to? Colin’s point above is obviously key, in that if this is the only way you can make money out of your customer base (in the short term at least), then clearly the % rates/£ fees will largely be determined by your funding needs, as opposed to your customers’ thoughts.
That said, I think if Monzo were able to undercut banks, it’s just another string in your bow to capture customers – people like me who could immediately save on interest charges by switching to you (irrespective of the great product you’re building). I think some kind of small (£50/100) interest free buffer could be cool, but as long as you don’t consistently use it, otherwise you should be charging for it. Other than that, I think a flat % daily fee is the way to go. Clean, simple, easy, transparent, and if you were able to undercut other banks – a win win all round.
Lastly, I think it would be cool if when you’re overdrawn, Monzo highlights your accumulated interest charges and lets you know when they will go out of your account, or you get debited daily so you know how much it’s costing. I don’t think paying a flat £ fee for a certain amount of overdraft (regardless of use) is the way to go, as invariably people that use all overdraft available are doing better than people that only dip into it for a short time.
Sounds good some new previews be good sneaky previews
I suppose there’s a choice between two products here (if you look at the common options that’re available now anyway) - you either:
Offer overdrafts to users with the expectation that they pay them bank, after their next pay day (which is the approach that Tom’s discussed before).
Offer overdrafts to users which they can keep indefinitely.
If you offer product 1, I’d be happy to pay a relatively high rate of interest (higher than the 18%-2…% that I pay for my credit card). Monzo could decide what to offer based on what the user could be reasonably expected to repay once their rent & direct debits for the month have been paid ( would know those amounts obviously), allowing for normal rates of defaults etc.
The real challenge is then working out what to charge users who don’t repay the overdraft in time.
If you offer product 2, I’d expect to pay a lot less for the overdraft. Lloyds Bank charges
19.89% EAR or 1.52% per month
I’m not sure how Monzo can differentiate itself from other providers, by using it’s data in new ways in order to work out how much to lend but that’s probably because I have basically no idea how banks decide how much to offer for overdrafts.
When it comes to the business model (which is worth discussing because it provides a framework to fit the product in), as long as the user can afford the monthly repayments for product 2, there seems to be very little incentive to repay the full balance which then means a reliable recurring revenue stream for the bank.
However, my assumption is that 's services (mobile, not designed to compete with credit cards offering rewards) appeal most to a younger, generally less credit worthy, demographic though so lending larger sums of money via product 2 might not be an option.
Since you also only plan to loan 10% of deposits, my guess is that product 1 is the route you’re more likely to go down…
I think an upfront % charge would be the fairest way. Monzo should be able to predict the amount of overdraft required for most users based on average daily spend and provide an estimated interest charge to the user to approve up front (clearly, the exact charge will vary depending on the precise overdrawn balances).
I would expect all customers to be credit checked, possibly different interest rates could be applied depending on customers credit worthiness, although the risk is that having differing rates dilutes the simplicity of the overdraft offering.
How about offering an offset of overdraft charges?
I go overdrawn by £100. Instead of charging me £1 for having done that you add it to a per customer ledger of payments owed. These payments are reduced by interest gained over the year. Any customer who doesn’t go overdrawn gets the full interest for their account. Any customer who is overdrawn gets their interest reduced by whatever they owe. If they fail to accrue enough interest in the year then it rolls over to the next and so on.
For this to work though, charges for going overdrawn would need to match interest rates or at least be close enbough that if you spend a majority of your year solvent then you shouldn’t have to roll over your ledger.
Does that make sense?
I’m aware it wouldn’t work well for those who are permanently overdrawn but the current banking system doesn’t either.
This is a great idea, but in practice, assuming the customer is credit worthy, being offered a longer term (or permanent) overdraft at a lower fee to any short term monthly arrangements, is almost certainly going to prompt everyone to take the cheaper option.
That said, not everyone is going to be credit worthy, so I still think this is a good idea. As someone who uses overdrafts quite a lot, the longer term option, at a discount to the shorter term option would be appealing (assuming of course this is still less than my other bank would charge, otherwise you’ll have lots of people doubting the need to switch). I’d even say that the shorter term monthly option still has to be less, or at least in line with the market norm (20% in Paul’s original post).
So let’s say you give someone an option for a £500 overdraft, specific to September, at a rate of 20%. In addition, because of a higher credit rating, or because they have demonstrated the ability to handle a number of the shorter term overdrafts, you offer someone the opportunity to take a longer term (6/12 months/permanent) £500 overdraft for 15%. That would seem reasonable and attractive. Almost incentivising better use of your Mondo account to get access to a better rate.
You could then take it a step further, and say that over the course of a year, if a customer has six individual months where they utilise a monthly overdraft (the short term more expensive option) you could cap any interest charges to the point that they would have paid if they were on the annual 15% rate – a bit like TFL do with your daily travel if you hit a point where it would be more cost effective to have bought a weekly travel card. This would go well with the “Monzo has got your (financial) back” type ethos you are promoting.
You might have answered your own question.
the ‘average’ rate of overdraft interest charged by UK banks is about
20%. In other words, if you borrow £100 it will cost you about 5p per
20%, or 0.0005% per day seems fine to me, but if you are worried about how that works for users, then word it how you did… representative based on real sums of money?
I would personally expect Mondo to be more transparent and to not charge any penalties for unplanned overdraft. Thats usually really expensive. So flat and clear fee for any overdraft.
Would be great to have some amount interest free, but I understand that you can’t probably afford it as it’s your main source of income.
Following on from this, I’d rather have offer me an overdraft, possibly in anticipation of my account running out of funds (based on the Pulse calculation) and then if I don’t take that overdraft, just decline my transactions, instead of allowing me to go into an unplanned overdraft - if that would mean additional charges.
It’s better to have the ‘hard stop’ as a prompt to top up my account, rather than incurring the charges without realising it.
Great to learn Monzo is exploring their Overdraft model.
How about this approach?
Charge £2 per week when someone is overdrawn. No stress. No mess. No complex percentages. Just a simple super clear charge that typically covers a time period someone might be overdrawn for until they get paid.
A £2 overdraft per week sounds extremely appealing to potential and existing customers.
But what about Monzo?
Let’s do some numbers:
Assume there are 50,000 Monzoites right now.
Maybe 20% typically go overdrawn each month for at least a week = £20,000 a month
Not much eh, but this might help Monzo keep focus on community and user growth.
Now if Monzo can convince just 1% of the 65million UK population to bank with them that’s 650,000 Monzoites. 20% overdrawn each month at £2 a pop = £260,000 a month or just shy of £3.2mill a year.
Sounds like a nice starter revenue to help move into other revenue models e.g. a Monzo like app market.
Hmm, scrap all that! I don’t think those numbers are good enough for Monzo.
Glad you’re hiring a Head of Lending and not me!
I’ll stick to providing product feedback, thoughts and ideas!
Hi @colin and thanks for sharing your thoughts
Your point about budgeting tools is really interesting and this has come up in discussions with the team and if this does result in customers using overdrafts or borrowing less then that is a positive as far as I’m concerned. Lending is not done ‘risk free’ and a provision is usually made for customers who can’t or won’t pay back. My gut feeling is that budgeting/targets will improve management of money, and that will lead to a lower provision charge. This is good for and customers.
On an ‘honest rate of interest’ I once heard that 80% of people don’t understand percentages and the other 30% don’t care with this in mind I think that it would be more transparent for overdraft fees to be expressed in £ and p whether or not we go we a %. Does that make sense?
On your last point, many lenders tend to do a mix of ‘internal data’ or customer behaviour and credit reference data - this is to get a fuller picture of the customers financial position. I know from personal experience that there is often a difference between what people think they borrow and what they actually do. Also, for customers that have a Court Judgement (CCJ) it is unlikely we’d want to lend to them - at least until they have been able to put themselves in good order again - perhaps with the help of our budgeting tools.
@fashburner ooo ‘interest free buffer’ a fascinating area of confusion in the traditional banks from my experience! Some banks have them, some don’t. For me this is an example of do we copy some of what the other banks do with buffers and limits and a list of exceptions as long as your or do we do something else.
‘accumulated interest charges’ now with comments I’m the traditional banks all have this but for some reason don’t share it…I’m sure we can guess why. You might just have pre-empted a future sneak peek!
Great post. It’s interesting to see you focus on pricing as the primary concern/feature, pricing is also a tool to manage lending and not just for profits sake.
I personally feel most people are pretty unresponsive to small detail pricing as most people won’t/don’t or can’t compare pricing effectively, and frankly don’t care or just tolerate it.
Overdrafts fall into two key products, the payday cycle and longer-term amortization of larger purchases. These should be distinguished.
Now a real and big problem with overdrafts is their habitual use, leading customers to see their negative balance as their ‘new Zero’, and remaining perpetually in debt (good for not so much ). A real game changer would be to use Gamifications to form habit change and clear the overdraft. You mentioned interest rates of 200-400%, after just a few months you would have enough money to rebate and reward certain behaviours through gamification and could potentially rebate some or all of the outstanding. This strategy also avoids the minefield of practical and PR problems for fining unpaid debt (i.e. there is no charge, just no rebate for defaulters). Charging a higher amount, and rebating good behaviour will also greatly reduce risk on your asset book.
You’ve convinced all of us to ‘refer’ our friends at signup, in an industry that have a near zero referral rate, through gamification. Have a go at doing the same for overdrafts
This is an excellent idea. I think earning a rebate back is something that will really appeal to a lot of people, and encourage the ‘correct’ customer behaviour. Really, really good idea!
I like the idea of getting a rebate for ‘correct behaviour’ but i worry that this might encourage some users to end up borrowing from somewhere else in order to get their rebate from Monzo.
I find this a really interesting area - made more interesting because its one of monzo’s primary revenue streams in the short term (the other being card fees)
My own views are inline with a lot of others (particularly @JamesC) around encouraging healthy financial behaviour (e.g. not relying on overdraft) - that is what will demonstrate monzo as being a ‘different’ bank and drive further growth.
A longer term concern here is is there sufficient revenue in providing current account banking if the accounts are free an noone is incurring charges. I feel overall here that our UK banking system is a bit broken here - we have people paying high interest/fees etc subsidising free accounts for others. Ultimately there is a cost to running a current account - surely this shouldnt sit with the people who can least afford that cost? (those in overdraft, those unable to repay credit cards)
Hopefully long term Monzo can move to a model based upon referral fees for ‘best in class’ products from other providers e.g. savings accounts, stocks and shares ISA, loans, credit cards etc
Funnily enough, I’ve just been watching this video that was recently posted where Tom compares Monzo’s approach of not charging fees to Google’s with GMail totally free accounts
I can’t find this quote now but I know that Tom’s commented in the past that the way works means that their overheads are much less like a bank’s [who have to maintain very costly back end infrastructure] and more like some other much cheaper businesses.
So doesn’t have the same need to
since those fees are also paying for the bank’s infrastructure and which makes it easier to earn sufficient revenue from the overdraft fees.
Thats true and I get the argument that Monzo’s infrastructure and operations overhead means it needs less income from other areas than traditional banks.
However Monzo have stated in their business cases that overdraft income is a necessary part of their business model which could potentially conflict at some point with an overall goal of decreasing overdraft fees.