From hard to soft to legal – transformation of the collection business model in Russia

Introduction

The article reviews challenges which the collection business in Russia has faced over the last few years, and the resulting transformation of its’ business model.

Relevance

The level of overdue debt in Russia is steadily rising. According to NAPKA (a professional association of collection companies) the amount of overdue debt offered by banks to collectors will grow 30% to 480 – 500 billion Rub. In the 9 months of 2020, overdue debt grew 19%, while consumer credit added only 10%. Experts estimate, that even if the COVID-19 pandemic finally stops its spread in 2021, overdue debt levels will continue rising. At the same time, the Russian Central Bank continues to impose stricter limits on retail banks’ capital requirements, which in turns motivates the banks to sell overdue debt in large amounts to clear their balance sheets. As a result, larger volumes of debt are purchased by collection companies. With consumer incomes falling and the state taking an increasingly harsher stance on protecting debtors, collection companies are faced with a challenge to adapt their business models to the changing environment.

Regulation of the collection business

The business of collection in Russia is relatively young. The earliest notable players in this market started their business in the early 2000s. At that time, regulation in the industry was limited, collection practices were questionable, and the future was very much up in the air.

In 2016, regulation finally came around. Federal law #230 defined the collection business, turned its control over to the Federal Service of Court Bailiffs, and established requirements that companies in the business must meet.

Requirements include, among others, minimum capital (10 million Rubles), possession of special software that ensures protection of debtors’ personal data, and 100% recording and storage of all voice exchange between collectors and debtors.

The law had since been changed a number of times, each change intended to further curb collectors’ activity and protect the interests of debtors. In its current version, Federal Law 230 also limits the number of calls a collector is allowed to make to a debtor, and even the time of day when such calls can be made (8 am to 10 pm on weekdays and 9 am to 8 pm on holidays).

Requirements are also imposed on individuals a collection company is allowed to employ. For example, collectors’ employees – who are, by definition, involved in collection overdue debt, are not allowed by law to carry any such debt themselves. On a side note, we must mention that the court bailiffs themselves are free from any such limitations.

Agent collection vs session collection

Collectors receive debts from banks (mostly) in the following two ways:

When employing agent collection, a bank continues to carry the debt on its balance, with the collection company acting as agent and earning a commission from the debts it manages to receive. The commission is usually anywhere from 15 to 30%, depending on how much the debt is overdue.

The session model means a collector is actually buying the debt from the bank. As a result, the bank is capable of writing the debt off its balance, and the collector becomes the new owner of the debt, which potentially leaves it in a position to collect up to 100% of the debt. At the same time a collector must find financing to purchase the debt and carries the risk for the amount paid.

Both models have pros and cons.

The agent model allows a collector to attract, in some cases, a very large amount of debt to service. It also allows the collector to funnel its funds to its infrastructure, instead of having to pay for the debts purchased.

The session model allows the collector to take a deeper approach and devote more funds and other resources to every debt, because the debt:

a) Is on the collector’s books, so it may not be called back as in the agent model;

b) May bring the company a lot more money, compared to the agent model.

Collection business models.

The collection process consists of the following stages:

Soft collection.

Soft collection is a stage of collection of overdue debt, which usually precedes legal collection. At this stage a collection company (or the original creditor, usually a bank) employs remote contact procedures, attempting to persuade the debtor to pay.

Remote contact procedures include

• Telephone calls and other means of voice communications
• Instant electronic messaging. This includes instant messages of all sorts – SMS, WhatsApp, etc.
• Email and other means on non-instant electronic messaging. This includes social networks.
• Traditional mail. The Russian law makes it mandatory for the collector to notify the debtor by traditional mail of the fact that the debt has changed hands. This is by far the costliest, the hardest, and the least effective means of modern communication that has in fact become obsolete years ago and will disappear from practice overnight once regulation of this matter changes.

At this stage, a collector is faced with the following tasks:

• Establish contact. This is most important as this stage. When collectors purchase debts, the original creditors turn over to them an array of assorted contact data for each debtor, which at first sight seems like more than enough to contact the debtors. However, modern lending practices, including competition in the field, do not allow banks to perform a quality check of their borrowers. As a result, the debtors’ personal data, including phone numbers, addresses and email, is usually incomplete, has changed since the time of borrowing, or has been initially false. This leaves collectors with a task to check and in many cases establish debtors’ phone numbers and addresses.
• Inform of debt. Many debtors have more than one debt, some have more than 5. Many have been given false or misleading information by their original creditor. As a result, a significant share of overdue debt is not being paid because the debtor is simply unaware of the debt. At the soft collection stage, it is a collector’s task to make sure the debtor is informed that the debt exists and need to be serviced (paid).
• Attempt to receive payment (at best) or at least a promise. This is, unsurprisingly, the hardest part. Debtors there days are not inclined to pay. Reasons for not paying the debt include:
• Loss of income (loss of employment)
• Large number of other debts
• Unexpected expenses
• Fraud of all kinds (including initially acting as a proxy when receiving the credit, etc.)

The efficiency of soft collection has been steadily falling over the last few years for the following reasons:

• Many debtors have more than one debt;
• Many have acting receiving orders, which means they already lose a part of their income to cover their earlier debts;
• Mass media have created and continue to support a negative image of collectors;
• Incomes in fact are falling, which means people are less likely to pay their debts voluntarily.

Hard collection

The task of hard collection is similar to that of soft collection, and it is to receive the debt. The major difference between soft and hard collection is the direct contact with the debtor in the case of hard collection. The main contact procedure in hard collection is paying the debtor a personal visit. During the visit, a collector aims to inform the debtor of the debt and discuss with him/her the possible ways (and timeframe) for the debt to become serviced.

Hard collection is more effective than soft collection, first of all because it bothers the debtors more. For the same reason, however, hard collection carries a lot more risks for the collection company. These risks include:

• Risk of all sorts of complaints a debtor may file with regulatory bodies, accusing the collector of extortion, and other form of illegal activity. To prevent and/or effectively answer to such complaints, a company must employ means of vocal and/or visual recording during debtor visits
• Risk of corruption from employees. Hard collection means dealing with the debtor directly, which includes in some cases collection of cash.
• Risk of illegal activity against employees. Debtors have been known to apply physical force to collectors, in some cases even using firearms.

Hard collection is also very expensive.

• Debts sold by banks are separated into lots by region. However, even if a company limits its purchases to a region/regions where it maintains a physical presence, many Russian regions cover the territory of a few European countries each. This calls for significant staff and transport expenses.
• A collector is capable of making 50+ calls in a day, while the same collector will only be able to complete 2-5 visits in the same day, should hard collection be employed.
• Staff profile for hard collection is very different from that of soft collection, this in turn calls for higher salaries in the hard collection field.

Soft collector (usually):

Female

Age – irrelevant

Education – irrelevant

Experience – none, or in banks, insurance, the Federal Service of the Court Bailiffs

Hard collector (usually):

Male

Age 30+

Education – legal, military, police

Experience – 90% police

Legal collection

Legal collection used to be the last step. At this stage, a collection company employs legal ways to make the debtor pay. This include receiving a court order (for smaller debts) or going to court with a claim (for larger debts). In both cases, the task of the collector at this point is to get a receiving order, which is a court document ordering a debtor to pay the collector (if the debt belongs to it) or the original creditor (usually a bank).

With the receiving order in hand, a collector turns the document over to the Federal Service of Court Bailiffs, which initiates a receiving procedure. At this stage, the task of the collector is to control the procedure, making sure the Federal Service is doing its job.

Legal collection is very different from soft and hard collection:

• Direct interaction with the debtor is limited or completely seized;
• All further steps are in the form of documents only and performed mostly by the collector’s lawyers;
• Successful collection of debt depends on quality of control over the receiving procedure performed by the Federal Service of Court Bailiffs.

Unlike soft and hard collection, legal collection may take years to complete, but in many cases leads to a full collection of the debt sum, with fines and expenses.

Transformation of business model

While soft collection used to be the choice of the collection business community, legal has gained presence over the last few years. The reasons for that include:

• Soft collection is no longer as effective, for reasons stated above;
• Hard collection is risky and expensive;
• Banks are more and more inclined to employ session, which means collectors have to buy debts. This is expensive and can only be justified by a greater return. This, in turn, is only achievable through legal collection;
• Legal collection allows collectors to form a steady and predictable stream of income, which makes them better borrowers. Collectors need capital, because banks need them to buy debts;
• Regulation is showing a clear path to more debtors’ rights. Legal collection excludes the need for direct communication with debtors, which in turn lowers regulatory risks.

Conclusion

The customer credit environment, along with increased regulatory pressure and higher capital requirements present collection agencies with a challenge to adjust their business model from soft and hard collection to legal collection.