The risk of outsourcing credit checks

A detail sprang out at me in the recent investigation into Mizuho Bank’s accidental funding of organised criminals in Japan. The bank funded loans via an associated firm, Orico, which acted as the lender, and had in turn outsourced the background checks it ran on customers. It turned out the background checks had not picked up on the criminality of certain borrowers.

Outsourcing front office functions, including credit and background checking, seems to be potentially fraught with risk. The problem with such offerings is that one could process a lot of checks at a sub-par service level and only get caught out when someone else checks your results more thoroughly; however if the employer has the capacity to do that, it is questionable as to the value they receive from outsourcing.

It would therefore seem likely outsourced services are difficult to check. Performance metrics in outsourcing these functions might be focussed on the efficiency of process and less on the correct identification of risky customers to onboard/sell to.

During the financial crisis the institutional credit rating agencies were lambasted for their failure to spot the firms’ failing business – and credit worthiness – ahead of the failure itself. Likewise the ‘self-certification’ mortgage model – self-certification could read ‘unverified’ – and the outsourced retail credit reference agencies were unable to spot the challenges that lay ahead.

The retail credit agencies were arguably closer to the source of the problem than the wholesale agencies yet they have been absent from any backlash. There may be a good reason for that, but regardless, one has to ask whether regulators ought to come up with a better method testing these sentinels. At face value they do not appeared to have fared well when tested by the market.