Simulation-based optimisation of the timing of loan recovery across different portfolios

• DOI: 10.1016/j.eswa.2021.114878
• Publication Date: 2021-03-18T14:56:19Z
• Authors: Arno Botha; Conrad Beyers; Pieter de Villiers
• Keywords: 1. No poverty; Computational Finance (q-fin.CP); 02 engineering and technology; Collections; 332; FOS: Economics and business; Credit loss; Loan delinquency; Expert systems; Quantitative Finance - Computational Finance; Risk Management (q-fin.RM); 0202 electrical engineering, electronic engineering, information engineering; Optimisation; Quantitative Finance - Risk Management

Accepted by the journal "Expert Systems with Applications". 25 pages (including appendix), 9 figures. arXiv admin note: text overlap with older arXiv:1907.12615<br/>A novel procedure is presented for the objective comparison and evaluation of a bank's decision rules in optimising the timing of loan recovery. This procedure is based on finding a delinquency threshold at which the financial loss of a loan portfolio (or segment therein) is minimised. Our procedure is an expert system that incorporates the time value of money, costs, and the fundamental trade-off between accumulating arrears versus forsaking future interest revenue. Moreover, the procedure can be used with different delinquency measures (other than payments in arrears), thereby allowing an indirect comparison of these measures. We demonstrate the system across a range of credit risk scenarios and portfolio compositions. The computational results show that threshold optima can exist across all reasonable values of both the payment probability (default risk) and the loss rate (loan collateral). In addition, the procedure reacts positively to portfolios afflicted by either systematic defaults (such as during an economic downturn) or episodic delinquency (i.e., cycles of curing and re-defaulting). In optimising a portfolio's recovery decision, our procedure can better inform the quantitative aspects of a bank's collection policy than relying on arbitrary discretion alone.<br/>