By Santosh Radhakrishnan, Vice President of the UK, five°degrees
How incumbent banks can differentiate themselves in a crowded digital lending marketplace?
Whilst banks have traditionally dominated SME finance, in the years following the financial crisis, we have seen SMEs turn to a broader range of suppliers for their finance needs. The financial crisis resulted in a subsequent increase in regulation meaning that banks implemented stricter lending requirements, deterring many SMEs from applying for funding. An EY study, entitled ‘Future of SME Banking Report’ shows that this led to a year-on-year reduction in the number of approved loans down from 112 in 2012 to 84 in 2016.
EY estimates there to be 5.5 million SMEs in the UK, contributing just over half of all private-sector turnover in the UK, yet these companies – from the hottest new tech startups to restauranteurs and florists – are struggling to get access to the sort of working capital needed to grow their businesses.
Getting a small business loan is a complex activity. The average “time to decision” for small business and corporate lending is between three and five weeks. Average “time to cash” is nearly three months.
The regulatory environment is getting more favorable for challenger offerings with laws increasingly providing an impetus to the digital lending market. More than 50 institutions have been granted a banking license in the UK since 2008, with a number focusing on the SME banking market.
If big banks want to protect a crucial market from being further eroded, they need to address the root causes of SMEs turning towards alternative sources of finance. There are a few fundamental drivers which are all coming together to help incumbents differentiate themselves in this space:
Challenge the challengers: creating a new digital lending initiative
Pre-crisis, the market was served primarily by traditional banks and specialists; post-crisis, a number of new entrants such as fintechs and challenger banks have emerged.
Big incumbents need to realise the full potential of digital lending will require skills that do not adequately exist today with the incumbents. Moreover, the organisation’s culture required to breed digital lending is very different from the legacy culture prevailing at traditional lenders. Only then will lenders have the resources and experience they will need to either fund or spawn a new digital lending initiative outside their current environment.
Leveraging rapidly changing technology to stay relevant in the digital age
There have been some rapid technological advances, led by the ever-increasing penetration of smartphones as well as the proliferation of data. Harnessing the latest futuristic technology will be key not only for banks but also for the challengers. Technological advancements will disrupt customer experience – how consumers research and apply for a loan, as well as the onboarding experience.
Data and automation, linked with the data explosion, will revolutionize underwriting providing an option to offer credit to all. A machine learning and deep learning approach to assessing credit worthiness and data-driven decision making across the loan lifecycle, will help incumbent banks fight the adverse effects of centralising credit decision-making.
Full scale digitisation of operations: technologies such as biometrics enabled authentication, e-signatures, e-mandates, AI, machine learning and block chain will enable ‘zero human touch’ lending and monitoring. Several back office as well as many mid office roles will become redundant in the near future.
With the rise of challenger offerings, it’s important that traditional banks and financial institutions equip themselves with technologies that can keep them relevant and ahead of the competition within the lending landscape. Many of these disrupting fintech startups have capitalised on the demand of customers to have access to funds instantly with seamless transaction experience. As a result, they have been at the forefront of digital lending. Most have managed to bring “time to yes” down to five minutes, and time to cash to less than 24 hours.
Build partnerships to fill capability gaps, most importantly with fintechs & challengers
In McKinsey’s Future of Risk Management Survey, 85 percent of risk managers viewed legacy IT infrastructure as the main challenge in digitisation. To address this challenge, many large financial institutions have partnered with fintechs. The partnerships enable banks to develop new capabilities and present new customer offerings more quickly.
In order to build the new digital capabilities required to redefine consumer lending journeys and expand the scope of credit to those previously underserved, lenders will have forge partnerships and collaborations—with credit bureaus, technology companies, third-party processors and most importantly the fintechs and challengers.
Harnessing the power of ‘Open Banking’
Finally, banks need to harness ‘Open Banking’ by opening up their APIs to offer a far more unified, flexible and efficient approach to lending. By teaming up with technology providers, banks can offer truly multi-channel, self-service lending products, with loan processing and collection, screening, credit scoring and underwriting all offered as a single end-to-end process.
For banks to be future proofed, ‘Open Banking’ is the key to ensuring high levels of customer service and greater flexibility to their lending product offerings. Banks must now ‘adapt to the new normal’ for them to continue to meet the expectations of their customers. Only this approach will allow banks to be ready and to stay competitive.