By Jonathan Phillips - May 17, 2022
Health insurance: the impact of COVID-19 on health services
The last few years have had a tremendous impact on
If you have spent months waiting to be approved for a mortgage, you’ve experienced some of the problems of legacy lending. But if you’ve logged onto a retail site and borrowed money for a consumer purchase in a matter of minutes, you’ve witnessed the future.
Many competitors have risen to disrupt the traditional financial sector in the past decade. Lending pioneers are some of the challengers rethinking old models by offering loan application, disbursement and management through digital platforms. In 2019, the digital lending sector was valued at $5.6 billion. But by 2027, it is predicted to grow to $20.3 billion.
We are living through a remarkable change in the process of securing loans, but also a shift in the players that are offering lending services. The rise of fintech has been precipitous, with companies like Monzo or Revolut revolutionizing the banking experience. Yet as well as these prominent players, unlikely lenders have also risen up to offer consumers and businesses new ways of borrowing money.
Lending is being democratized, with new players and industry veterans competing to build compelling, customer-focused systems which offer frictionless access to loans and other credit products. If we can just borrow your time for a few minutes, here’s what this lending revolution means for the future of finance.
New Competitors in an Ancient Industry
Financial institutions have offered loans and credit for thousands of years, with evidence suggesting lenders and proto-banks were operating as far back as 2000 BC in Assyria, India and Sumeria.
The in-person transactions required for these ancient loans may have looked somewhat familiar to 20th century consumers or businesses, who were often forced to go into a branch or at least speak to a human on the phone to arrange a lending agreement. Today, the lending process is becoming so different that the average ancient Sumerian wouldn’t have a clue what was going on.
Firstly, a lending journey can now be completed without ever having to speak to a human. Secondly, there has been a marked change in the type of organizations that engage in lending. Businesses trading on Amazon can now borrow money from the retail giant itself, for instance, after it teamed up with Goldman Sachs to offer its merchants lines of credit worth up to $1 million. Amazon has access to data about its sellers’ success, so can make expert decisions about risk and future performance.
Apple has also launched its own credit card, whilst Google has introduced a virtual debit card which some commentators believe is a forerunner to a fully-fledged credit product. Lending is no longer the preserve of the big banks and global financial giants, but a sector with many small and large competitors.
Alternative lending is also shaking up the financial world. In May 2021, Morgan Stanley told investors that this emerging sector represents “a secular shift in the way consumers and small businesses access capital”.
“Alternately referred to as marketplace lending, peer-to-peer lending and P2P lending, alternative lending takes place through online platforms that use technology to bring together borrowers underserved by traditional lending institutions, with loan investors seeking attractive yield-generating investments,” it wrote.
This lending model grew from small unsecured consumer loans and now encompasses small business lending as well as financing for commercial and residential real estate or other big-ticket borrowing.
As the world went into lockdown, researchers from Cambridge University’s Judge Business School found that global alternative finance volumes grew by 24% in 2020. It defines this sector as “channels and instruments that emerge outside of the traditional financial system”, which includes non-banks. The figures it released are startling, suggesting that global digital lending and capital grew to $113 billion between 2018 and 2020, a rise of 27%. The US and Canada is now the largest regional alternative finance market ($73.93bn), followed by the UK ($12.64bn) and APAC, which is worth $8.9bn.
This poses a serious challenge to traditional financial institutions, which are now competing with a range of new entrants into markets they used to own. Can financial institutions learn from their competitors and forge a new future?
The Fintech Effect
Fintech attracted $43 billion in venture capital during the second quarter of 2021, accounting for one in five dollars of all the venture funding for the entire year. In KPMG’s list of the top 10 global fintech deals of 2020, two of the companies involved offered lending services. Intuit, a software company, bought Credit Karma for $7.1 billion whilst the private equity firm True Wind Capital snapped up Open Lending for $1.3 billion.
However, this doesn’t mean banks are out of the game. The J.D. Power 2021 US Consumer Lending Satisfaction Study found that traditional financial institutions were striking back. Overall, fintech lenders saw overall satisfaction scores decline by 5 points on a 1,000-point scale this year due to “slower application approval times and tighter credit criteria”.
Traditional lenders outperformed fintechs in categories such as “putting the customer first” or “providing guidance”. The study also pointed to different user behavior, with people who relied on traditional lenders more likely to use mobile apps in contrast to fintech customers, who were most likely to use a computer. Banks can win when they offer familiar products such as mortgages, overdrafts or small business loans using the latest mobile software with finely honed user interfaces.
Banks and other financial institutions also benefit from being a “one-stop-shop” where a number of services are offered in one holistic whole. Fintechs started off by “unbundling the bank”, offering individual services including lending. But Deloitte now believes fintechs are “bundling it all back together again”. Revolut started as a travel card which provided cheap insurance and is now a fully-fledged lender offering loans and credit cards. Banks already have these services in place, so are in a good position to cement a strong customer base by offering a holistic, all-encompassing bundle of products which can keep their customers loyal across a range of services.
Financial institutions are also partnering with fintechs, particularly in the open banking sector, where APIs are used to allow third-party developers to build apps and services for financial institutions. Craig Vosburg, chief product officer of Mastercard, believes open banking will “create more financial opportunity for everyone” – which presumably includes the giant financial incumbents as well as fintech startups which power new ways of lending or the small businesses which benefit from easy access to these services.
Big finance is already buying up the upstart innovators. Visa recently announced that it was planning to acquire open banking startup Tink for more than $2 billion, which is just one of the many acquisitions shaping the space. Financial institutions are also opening up to competitors, allowing them to build services on top of their own systems. In the US, a startup called Blend is now processing $5 billion in mortgages every day, with its software powering applications on the websites of US Bank and Wells Fargo. By partnering with software-as-a-service companies, banks can bring new digital products and services to market at high speed and benefit from the agility of fintechs without disturbing their usual business practices.
Tools of Change
Lending is now a very different process from its traditional forebear. On digital platforms, lending is often embedded right into the customer journey. This can be seen in action at Klarna, which offers credit and short-duration loans at the checkout of retail websites.
In a wider sense, lending has shifted away from being an activity based around physical branches or call centers towards a fully digital self-service experience. Fintechs are now able to leverage data to build an unprecedently accurate risk profile of loan applicants. Automation allows risk to be constantly assessed at speed, powering continuous underwriting and enabling online systems to perform roles that once required humans.
The Big Four accountancy firm KPMG said that “data management is at the heart of lending transformation”, noting that some processes for borrowing money remain stubbornly manual. Mortgages, in particular, require up to 100 steps. Data about clients’ risk profile and financial history can speed up decisions, particularly when combined with artificial intelligence which automates key aspects of the process. This allows lending and many of the other functions of a financial institution to be performed without time-consuming manual labor.
“Banking has changed irrevocably as a result of the pandemic. The pivot to digital has been supercharged,” said Jane Fraser, president of Citigroup and CEO of its consumer bank. She believes the “model of the future” lies in “a light branch footprint, seamless digital capabilities and a network of partners that expand our reach to hundreds of millions of customers.”
Legacy financial institutions and plucky startups can both thrive in this new normal, as long as they continuously innovate. In a world changing at speed, the choice for lenders is stark: digitize or decline. Don’t get left behind.
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