Remaking credit: the future is digital lending

July 2020  |  FEATURE  |  BANKING & FINANCE

Financier Worldwide Magazine

July 2020 Issue

The state of the global economy – both at present and pre-coronavirus (COVID-19) – is such that financial institutions (FIs) are exploring a number of pathways in order to achieve a semblance of equilibrium. One of these is digital lending.

The term digital lending basically means lending through a digital platform – from receipt of a loan application to disbursement. Although gaining momentum, digital lending (also referred to as alternative lending) is very much an emerging discipline.

Up until recently, the use of digital lending platforms was certainly meagre. A study by Bain & Co found that only 7 percent of bank products were handled digitally from start to finish, including 0.1 percent of small business loans. Another study, conducted by the American Bankers Association (ABA), found that “relatively few banks” were taking advantage of digital opportunities for commercial and small business loans. Indeed, about one quarter of those surveyed used digital loan origination for small business loans and only 11 percent offered digital commercial lending.

Since then, there has been a stronger response from the lending and credit community. “Around the world, lending models in the last few years have seen frenetic activity,” notes the Boston Consulting Group (BSG) in its analysis ‘Digital Lending: a $1 trillion opportunity over the next five years’. “Initially, the juggernaut was led by FinTechs, but a few traditional lenders have followed suit.”

Furthermore, says BCG, there are four fundamental drivers boosting activity in the digital lending space. First, consumer behaviours are changing dramatically, shaped by experiences offered by internet giants. Second, there have been some rapid technological advances, led by the ever-increasing penetration of smartphones as well as the proliferation of data. Third, the regulatory environment is becoming more favourable with laws that are increasingly an impetus to digital lending. And fourth, there have been some remarkable innovations in the operating models of lenders, resulting in an exponentially growing market.

In the view of Thangaraj Ravikumar, associate professor and research coordinator at Christ University’s School of Business and Management, digital lending has gained a lot of attention and recognition in recent years because of its innovation, speed, promptness and efficiency. “Digital lending, unlike the traditional form of credit lending, is more inclusive in nature,” he adds. “It also covers individuals and businesses, especially small and medium-sized enterprises (SMEs), that do not have a credit history or are deemed to have a low creditworthiness.

“Bad loans are also less likely with digital lending, as users are checked for their credit behaviour through traditional, as well artificial intelligence (AI)-based, algorithms,” he continues. “Digital lending methodology looks not only at an ability to pay, but also a willingness to pay.”

Ultimately, the aim of FIs is to have every stage of the loan lifecycle – including application processing, borrower evaluation, decision management, disbursement to servicing, collateral management, collection, reporting, archiving and compliance – fully automated.

“Even without the unprecedented global health pandemic and the economic crisis, the lending industry was on the verge of full-on digitalisation,” contends Elena Ionenko, co-founder and chief business development officer at Turnkey Lender. “The question is not which parts of the lending process to automate or digitalise, it is how to make every step of a loan’s lifecycle fully digital, automated, secure, efficient, low-risk and streamlined.”

Key advantages

Drilling down into its mechanics, there are a range of benefits that digital lending offers both FIs and consumers. “Digital lending gives FIs additional data points, such as browser cookies to conduct targeted marketing and direct outreach, enhanced controls of information outflow compared to human interactions, as well as a simpler way of testing to monitor performance and remediate challenges, including A/B testing,” explains Kaylin Kugler, managing principal at Capco. “For the customer, the experience is simple, efficient and transparent, with many FIs also giving applicants the opportunity to track where they are in the application and funding process.”

Further key advantages of digital lending are its cost and speed. “Digital lending is advantageous for customers due to its inclusiveness, affordability, speed, convenience, simple procedure and documentation,” affirms Mr Ravikumar. “For a digital lender, the cost of lending comes down drastically and the recovery of a loan is also simple and cost-effective. Furthermore, FIs are able to attract new age customers, as well as retain existing ones.”

That said, similar to paper money, digital lending also has its disadvantages. “These include putting a limit on face-to-face relationship-building opportunities for high dollar loans and high-net-worth individuals, pushing an offering to market too quickly that is not true to brand and which negatively impacts customer experience, or building an imbalance between high-tech/high-touch channel priorities – such as ignoring investment in branches and call centres – and losing those customers in the long term,” says Ms Kugler.

A further downside, as noted by Mr Ravikumar, is that digital lending may not be able to attract all sections of society, perhaps favouring borrowers who are literate in information and communications technology (ICT).

All things considered, the benefits of digital lending would appear to heavily outweigh its downsides. “Digital lending, if done right, helps FIs process and approve loans faster, reduces credit risk, cuts operational costs and increases customer lifetime value,” says Ms Ionenko. “But, most importantly, it helps address key customer requirement in 2020, the beginning of a new decade in which digital lending offers almost instant disbursement and fair rates.

“Traditional lenders used to think that borrowers will keep on coming to branches for loans indefinitely,” she continues. “But the stability of financial products and services that we all got used to does not exist anymore. So, the disadvantages of digital lending are non-existent, as there is no choice to make.”

Implementation

With FIs often having departments and functions with separate priorities, implementing a digital lending transformation is no easy task. Often there may be resistance to change, so it is important to have alignment across the board on the goals of the transformation from the outset.

“Given the level of investment and implementation timeline, a digital lending transformation must be a strategic vision of the FI and supported across all levels of the organisation in order to be successful,” suggests Ms Kugler. “FIs need to align to the strategic priorities at a senior management level and determine the implications of existing processes and technology – designing the optimal operating model while developing an enhanced customer and operational experience to achieve desired benefits.”

Clearly, changing traditional FI organisational structures is challenging, but ultimately necessary and beneficial. “FIs have realised that future credit transactions will be dominated by digital lending due to its innovative and customer-friendly approach,” says Mr Ravikumar. “Digital lending proponents cite ‘future survival’ to convince those resistant to change, that if they do not adopt the process, the opportunity will be lost to FinTech startups.”

Reinforcing the attractiveness of digital lending is the software as a service (SaaS) delivery model. “Intelligent SaaS solutions provide robust automation for every step of the lending process and flexibility sufficient for it to be tailored to any specific needs,” asserts Ms Ionenko. “The optimal way to automate the work of a lending operation is to deploy an end-to-end solution that addresses the needs of both the lenders and the borrowers.”

Market differentiation

As part of the process of transforming their credit management operations, FIs of course need to differentiate their digital lending service, promoting a service that improves customer experience and which leads to greater profitability and competitiveness.

“There are FIs that choose to compete with each other by perpetually adjusting their loan rates,” says Ms Kugler. “However, real market differentiation requires making significant improvements to the customer experience across all aspects of the end-to-end lending journey, such as prospecting, originating, funding and servicing.

“This customer-centric approach requires a continuous cycle of determining target segments and personas and speaking to them regularly, developing a design thinking mindset, along with the facilitation of customer journey mapping and operationalising change to remediate the known pain points,” she continues. “The focus will shift from competing with external FIs to differentiating through internal enhancements.”

Furthermore, to ensure greater profitability and to remain competitive, embracing disruptive technologies is key. “FIs need to adopt machine learning and AI to develop suitable algorithms to evaluate customers’ ability and willingness to pay, in addition to traditional credit scores,” suggests Mr Ravikumar. “Furthermore, FIs have to equip their workforce with the digital knowledge and skills to facilitate effective implementation of tech-based credit processes, as well as adequately invest in digital infrastructure.”

Beyond COVID-19

While digital lending has gained significant traction in recent years, in a post COVID-19 environment, its uptake is set to escalate. “COVID-19 has been the accelerator for a global digital transformation that was already taking place across the financial services industry, albeit at a slow pace,” believes Ms Kugler. “In the US, FIs are struggling to handle the demands of Coronavirus Aid, Relief, and Economic Security (CARES) Act inquiries without an entirely end-to-end digital offering.

“Once we see relief from COVID-19, we could see an immediate uptick in savings to prepare for future emergencies,” she continues. “However, lending will always be an important offering, with consumers more digitally-led, having been forced to adapt during the duration of the pandemic.”

Without doubt, due to the onslaught of COVID-19, a huge portion of the lending market is going to be available over the months ahead. “It is up to creditors to either make use of this opportunity or stay tied to business processes that were outdated even five years ago,” suggests Ms Ionenko. “After the 2008 financial crisis, e-commerce became an inseparable part of our lives.

“The 2020 COVID-19 crisis, among other things, will do the same for digital lending,” she continues. “By the end of the year, up to 95 percent of all loans will need to be originated, serviced and collected online. That is the new reality and if a lender wants to stay relevant, it needs to go fully digital as soon as possible.”

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Fraser Tennant