What is transaction categorization, and why does your lending company need it?

If you have ever wondered about the transaction categorization definition, your search is over. We have compiled a guide to understanding the meaning, the importance, and the need for transaction categorization for your lending company.

Aссording to a survey conducted by BBVA Data regarding the choice of bank, 46% of banking clients under the age of 30 said that the quality of a bank’s Personal Finance Management would highly influence the bank they would choose. This is completely understandable.

The tedious task of balancing your checkbook and managing your finances multiplies when you have no memory of the transaction category. For you to completely understand your finances, you need to know where and on what you spend the money. If you have to manually classify your transactions, you end up spending twice as much time managing your finances – plus it is not that fun.

Time is money, and if you want your customer to be happy you have to provide them with the means to waste as little time as possible. That is why we consider transaction categorization API to be one of the most important features of an innovative financial company.

What is transaction categorization?

Transaction categorization is a feature which aids your retail user to categorize or split (into more than one category) a particular type of transaction. This feature comes in very handy for the expense and budget analysis.

This option allows the retail user to put their expenses under different categories. The result list shows them their bank name, account number, date of the transaction, remarks, category, amount type, and any other additional aspect of the users’ choosing.

Transaction categorization benefits are the ability to recognize the purpose of a transaction based on its description, it is made with a focus on risk and financial behavior.

If you want your user experience to be great you have to support them in every way. This feature is becoming a standard characteristic of online banking. It definitely is a great development, as now banks consider this to be a must-have attribute for their customers.

But the issue is a lot of companies do not understand that this is not only a basic requirement, but it is an essential strategy for superior user experience in digital banking. But it is not as simple as that – you have to have your own strategy for the best transaction categorization for your user. Remember, every customer has a different type of need depending on the type of your business.

Why does your lending company need to have a transaction categorization?

It is no surprise that financial companies need to help their customers by organizing their finances. When users know what they spend their money on, they end up keeping their balances in check. If it is a debit account, then it might not make a big difference to the bank itself, since the money fully belongs to the user, not the bank. But it is still advised to help your customers with their financial management.

But when it comes to a lending company, loan transaction categorization makes an even bigger difference when compared to the banking sector. A lending company knows little about its potential borrower’s expense history, and even though a bank statement may certainly be requested during the loan application process, it still gives a little idea about the spending patterns and risk factors. This is where online banking and credit card transaction categorization becomes very important. And besides that, it makes a lot of sense to help users manage the money they borrowed from your company.

By categorizing the expenses of your customers (or even by giving them an ability to do so), you end up gathering more information about them. Below are the five advantages to using transaction categorization for lending companies:

1. Real income verification – usually loan applicants have multiple incomes. Gathering this data will help you identify their full salary for credit scoring purposes.
2. Active loans verification – gather better insights on active liabilities. This account data will allow you to identify all incoming and outgoing loan payments.
3. Find risk-reducing behavior – this user data might provide additional reasons for application approval. If a customer has been defined as “high risk”, this data might show you the reasons for previously overdue loan payments.
4. Identify unusual behavior – recognize potential fraud cases by maintaining a healthy loan portfolio. Account data will allow you to notice potential fraudulent behavior, including payments to other “secret” accounts, fake salary payments, etc. This will give you a chance to automatically identify high-risk customers and reduce administration costs.
5. Check for red flags – credit history gives you a perfect first impression of a loan applicant, but for a fuller picture you need to look into additional details. Data gathered from credit history transaction categorization will give you a chance to find any red flags from the customer’s financial history to pick the right applicant for approval.

Additionally, your company itself will gather the needed data to receive even more customers in the future. When you know where your users spend the money, you can look for even more potential customers in similar situations.

What types of businesses can use bank transaction categorization to the fullest?

Though this article is written specifically for lending companies, it does not mean it is not useful to other types of digital financial institutions. Below is a short list of businesses that can also use the same, or similar strategies to become more successful.

• Central, retail, and commercial banks
• Digital banks
• Credit Unions
• Online payment services
• Investment banks and companies
• Brokerage firms (similar to the South African FX broker companies listed here)
• Insurance companies
• Lending companies

Obviously, this type of service is not just useful for financial institutions. You have the ability to create an independent transaction categorization application and act as third-party support to your customers.

What are some financial transaction categorization strategies?

We feel it is important to think everything through in detail. As stated above, every lending company has its own strategy needs, but that does not mean that some common strategies do not exist. Below you will find the two most common strategies to utilize your user transaction categorization information.

Use customer account data to generate value

After the development of the open banking initiative, it has become possible to significantly increase the value generated from the user account and transaction categorization data. Financial institutions have a chance to take advantage of the information they find to bring their business more successful. Do this by analyzing all of your data in detail, to avoid any kind of financial risk for your business. When you have enough information about your user by their transaction data, you can avoid scammers with ease.

Besides, you will get to know your average user well enough to gain more referrals for more customers. Though transaction categorization is an outstandingly useful feature for your business, you can also improve your overall customer experience.

Common misconceptions regarding what constitutes a good categorization experience

We listed the three most common strategies to make your customer happy. Now, before you start working on your own strategy, we want to give you some tips on common pitfalls. Often, companies end up making their strategies too complicated due to perfectionism. See the most common misconceptions below.

100% categorization accuracy

It is impossible to always get the category perfectly. Customers might end up being dissatisfied with their transaction categorization results. This could happen for many reasons, for example, the user goes shopping for a present and buys a toaster. It falls under the category Appliances, but the user is highly motivated to keep track of their spending and would prefer for it to go into the Gifts category. But it is impossible for the financial company to know what the user is doing in reality. That is why it is important to give the users an option to customize their transaction categorization perfectly and employ various bank transaction categorization machine learning techniques that will not only evaluate the origin of the translation, but also the place and time.

There should be one category for each transaction

It is a common misconception to think that one transaction must have one category. The user might wish to track everything in detail and classify one transaction in one or three categories. That is why it is important to give the user the ability to choose, and even give them suggestions for other relevant categories to simplify the process.

Categories should not have sub-categories

This ties to the paragraph above. If you create a category Restaurant, is that enough? No. What if it is a common fast-food restaurant, and the user wants to also track their fast-food consumption? That is why it is always advised to create a fully detailed transaction categorization. You want the user to have the best and easiest experience.

You only need to implement one transaction categorization engine

Do not abandon the service after you fully implement it. Users always develop new needs. You must keep up with them and give them constant updates to make their experience the best. If you want to keep your customer loyalty, you need to stay loyal to them. Do not stop updating your list and your software just because your initial release was successful. The ever-changing consumer behavior means that your application must keep up with the trends. It needs to become smarter, faster, and adaptable. And in case you are using a vendor for this technology, why stop at one? Try out a few options simultaneously, A/B test them and see which one delivers the best results for your users and your business.

So what’s the take away on categorizing financial transactions?

Hopefully, we gave you enough proof to see that in this modern world transaction categorization is essential to a successful digital financial company. In the end, all that matters is to keep your customers happy.

Here are quick tips for great customer engagement:

• Give your customers an option to customize their transaction categories
• Create a clear strategy and goal following your user data
• Provide an option for uncategorized transactions
• Try to predict a category for your user, but also give other suggestions to help them personalize their personal finances
• Always adapt and upgrade your application by listening to your customers
• Give your users a chance to tell you how they feel