It’s never easy when unemployment rates are high and job creation is at a standstill. While these situations produce high-stress levels for individuals directly impacted by them, financial institutions undergo their own challenges in these circumstances, as many of them may experience a dip in the performance of their customer base.
Financial institutions, such as banks, credit unions, and loan agencies, provide services to help people achieve financial stability and improve their quality of life. However, when unemployment rises and people have less access to funds, this can hurt the revenue stream of these organizations. Fortunately, there are several ways financial institutions can adapt to these challenges while improving their services at the same time.
In this article, we’ll discuss how unemployment rates impact banks and how financial institutions can adequately prepare for the inevitable fluctuations.
Unemployment and the Economy
Unemployment and the economy are strongly linked. High unemployment rates can trigger a recession, while low unemployment rates might indicate a more prosperous economy. This close association means that a rise in joblessness can cause a chain reaction in the overall economy. A lack of jobs means people have less money to spend on consumer goods and services, which can trickle down to other industries. And as those industries see declining trends in consumer demand, the price for goods and services balloons.
The labor participation rate is one of the most critical factors regarding unemployment and the economy. It’s a measurement of people who are actively working or looking for work, as opposed to those who have given up looking for employment. The higher the percentage of people who are either employed or unemployed but searching for work, the better the economy will be. Conversely, if fewer people are participating in the labor force, it could cause a ripple effect, even generating an economic downturn.
How Banks Are Impacted By Unemployment
Banking institutions play a significant role in job creation for people all around the globe. They’re responsible for creating work opportunities in accounting, banking, insurance, and mortgage lending. During times of high unemployment, however, banks may come under stressful conditions that cause them to have to reorganize their operations to stay profitable. But that’s not the only way unemployment rates impact banks. They also have to contend with:
1. A Rise in Loan Defaults
As more people lose their jobs and struggle with their finances, they’ll begin to default on their loans. Rising loan defaults cause a lot of damage for banks because it forces them to take losses on assets that were once considered “safe investments.”
2. More Risky Borrowers and More Credit Card Debt
When unemployment rates are high, people have trouble paying off their credit card bills and other forms of debt. As a result, individuals may have no choice but to take out new loans to pay off old ones or simply live without basic necessities, such as food and shelter. In areas where unemployment is higher than in other parts of the country, this can present a much higher risk for the banks.
3. Higher Interest Rates on Savings and Loans
High unemployment rates also negatively affect a bank’s ability to increase its customer base. Fewer customers mean that banks may be forced to charge higher interest rates on savings and loans to make up for the loss of income. Changes in interest rates can impact all of the people who bank with financial institutions, but it can be devastating for those who are already struggling to make ends meet.
4. Lower Property Values
As more people are forced to sell their homes at a loss, property values will drop. Lower property values make it even harder for people to get out of debt and may cause the unemployment rate to rise even higher. Fewer people buying homes means fewer buyers for new properties, which dissuades developers from building new homes in the area. This chain reaction impacts banks’ bottom line, and they may be forced to take other drastic measures to protect themselves.
How Financial Institutions Can Prepare for Fluctuations in Unemployment Rates
When unemployment rates are high, financial institutions need to take quick action. Below are four practical steps banks and other financial institutions can take to avoid being caught off guard.
1. Understand Your Client Base
Understanding your client’s needs is one of the most important steps that you can take as a financial institution. If you fully understand who your clients are, you will be in a better position to provide the kind of service they need and avoid losses when unemployment rates rise. For example, if a significant portion of your client base is unemployed, it may be time to consider offering more flexible terms for loans and mortgages.
2. Stabilize Your Assets
When unemployment rates rise, the risk that some customers will stop making payments on their debts increases. One way to protect yourself from this is by investing in short-term assets that can be quickly liquidated if necessary, which will improve your bank’s liquidity overall. The more liquid your bank is, the less susceptible it will be to problems caused by economic or government policy changes.
3. Consider Offering New Services
A rise in joblessness might trigger an increased demand for certain kinds of loans and services that were previously not needed or requested very often by clients. You should examine these requests closely and see if they fit into your business model or whether they would require too much time and effort to implement properly. For example, if several clients need small business loans but don’t want to apply online, you could consider hiring additional staff so as not to lose out on this business.
4. Consider Raising Interest Rates
During a downturn, your bank may be able to increase its interest rates on loans and other products and services without losing customers. In most cases, customers are more likely to stick with a bank they already have a relationship with, even if they have to pay higher interest rates than they would with other banks. If you offer home equity loans, you could raise the rate of interest a few points without losing any business. If you can afford to do this and are willing to risk increasing your costs, then it could be worth doing to protect your profits.
Forging Ahead in a World of High Unemployment Rates
High unemployment rates can be difficult to navigate, especially since the landscape shifts every day. But with the right partner and the right data, it’s possible to come out stronger than before. Lumos provides business lenders and financial institutions the data solutions they need to make the right business decisions regarding their clients’ portfolios when it matters most.
If you’re looking for real-time access to client performance data supported by robust risk analysis intelligence, schedule a demo with Lumos today.