Universal Credit: The online lending revolution

Back in early 2005, the concept of online lending was an anathema. If you needed a loan, you made an appointment to see a personal banker, donned a suit, and then prayed that your finances and business idea were enough in line with the bank’s borrowing requirements to get the loan approved. 

But later on that year, a disruptive UK fintech company called Zopa threw a spanner in the works and became the very first online P2P lender in the marketplace. Incumbent suspicions were raised. Zopa was viewed as niche and even shady by the establishment. 

“It’ll never catch on,” they said. 

Fast-forward 15 years and online lending has taken the marketplace by storm. Indeed, these days, the incumbents are the ones lining up to form collaborations with their shiny fintech counterparts.

The game has well and truly changed as billions of dollars in lending transactions occur daily across the globe. 

Lending frenzy?

Although there are obvious benefits to more accessible loans, which have helped numerous businesses develop and grow, not everyone is happy about this financial revolution. Indeed, some experts are concerned that such easily accessed loans on a consumer level could potentially be damaging. 

Elin Helander is a neuroscientist and the Chief Scientific Officer at Dreams, a leader in behavioural banking solutions that helps users set saving goals, invest and pay off debt.

Not one to mince her words, Helander says the trend towards buy-now-pay-later (BNPL) schemes, which have exploded in recent years, could lead to serious problems as they target younger generation spenders and propagate a culture of debt.

“A concerning by-product of the online lending revolution has been the emergence of buy now pay later schemes (BNPL) over the past couple of years which are marketed almost entirely to millennials, brainwashing them with the idea that debt is a good thing,” she says. “There’s something inherently and morally wrong about that, and if the online lending revolution doesn’t slow down any time soon, we risk a significant consumer financial crisis.”

Helander goes on to say that with the introduction of new regulations like Open Banking and PSD2, the number of fintechs has skyrocketed, and the level of competitive intensity within the online lending market is now the highest it has ever been. “The online lending revolution does not look like it will slow down any time soon,” she points out, stressing that this level of competition has motivated fintechs to use “aggressive marketing tactics to catch the eye of consumers, luring people into making loans they might not necessarily need, and reaping profits from desperate borrowers.”

Expanding on her statement, she explains, “In behavioural economics, people are often defined as being ‘loss averse’, meaning that they have a tendency to prefer avoiding losses rather than acquiring gains. 

“This concept of loss aversion explains why when you buy something and have to remove money from your account, a moment of mental pain arises. Marketers use this concept to entice young consumers by removing the pain associated with the buying process and giving people the false sense that they have bought something for ‘free’”

Loaned opportunities

However, Helander’s dissenting voice is not echoed by the majority of fintech experts, who support the new online lending revolution and see it as a positive force. Many dismiss the idea that easier access to loans results in a culture of debt and borrowing. 

Sankar Krishnan, Executive Vice President at Capgemini, Industry Head, Banking & Capital Markets, agrees that the majority of online borrowers are in the younger generation but says easy access to credit is essential for innovation and growth. “Millennials and digitally-savvy consumers are increasingly borrowing from smart fintechs. The Digital Lending Market is expected to grow by approximately 11.9% CAGR between 2020-2025,” he says, adding that lessons have been learned from previous market crashes.

“It is very good for small businesses and individuals to have access to ready credit. At no stage should a bad credit be pushed forward as good credit, as we still have to remember the lessons from the subprime mortgage crisis of 2007. Availability of credit is a factor of production, which propels the engine of the economy.”

Krishnan goes on to say that far from providing a counterweight to the online lending trend, incumbent banks are swiftly adopting the same technologies to help them stay ahead of the curve. Krishnan believes banks need to be more digitised and change their attitude to lending. He points out that those operating via customer-centricity will “thrive” because they will realise “the needs of customers at the lowest cost point, and reconfigure their business model to be agile and nimble” accordingly.

He adds, “ Let us not forget that we need large banks for big-ticket lending to Fortune 500 companies, and we need them as a “utility” to serve the global lending market. But for small loans, fintechs present a better alternative.”

Patrick Meisberger, Managing Partner at CommerzVentures, a return-driven, non-strategic venture capital investment company founded in 2014, says the amount of regulation applied to lending is strict enough to protect customers as well as lenders. “There is a lot of regulation involved with lending overall, but this applies equally to banks, and it is right that consumers should be protected.”

Meisberger explains that alternative lenders sprang up because incumbent banks were not sufficiently servicing the market demand. This revolution was driven by the incumbent bank’s lack of a digital offering. “Their reliance upon lengthy processes that were paper-based or requiring ‘in person’ applications at local branches, meant that lending challengers could reach consumers - especially the unbanked - by taking advantage of advances in Big Data and AI.”

A welcome disruption

Uma Rajah, CEO of Prime property lending platform CapitalRise, believes the legacy systems were ripe for an overhaul because they were old-fashioned, cumbersome, and time-consuming. It was this situation that launched the fintech revolution, which, she says, now better serves both customers and lenders.

Since the start of the pandemic, she points out that online lenders have provided an essential service to businesses and consumers alike.

“It should make no difference whether a business is offering consumer loans via an online platform or offline, as they are subject to the same rules which are designed to protect customers. As long as all platforms are compliant, the online lending market will increase access to credit for people who need it, which, in a COVID-impacted world, is more important than ever.”

Rajah says the opportunity to use technology to streamline processes in order to deliver fast, convenient, flexible finance to all types of borrowers has been instrumental in driving fintech's online lending revolution.

She adds that fintech has thrived in a customer-centric environment that delivers according to user needs. Banks must adapt and digitise or be left behind. “We live in a tech-driven world, and there is no going back. There is an expectation that things should be done instantly and conveniently – online.”

Lending and COVID-19

According to some experts, the pandemic-driven demand for online lending is equally split between consumers and commerce. Ian Johnson, SVP, Managing Director, Europe for Marqeta, explains, “Many consumers faced interruptions to their income, and needed access to funds quickly to make ends meet. Businesses were hit by closures and disruption too, needing access to capital so they could keep their doors open.”

With so many businesses applying for Coronavirus Business Interruption Loans (CBILs), traditional lenders couldn’t keep up. Alternative lenders stepped up to meet demand and turned the industry on its head, points out Johnson. “By offering businesses smart loans based on real-time data and seamless online experiences, credit provided by alternative lenders has skyrocketed, kickstarting the lending revolution,” he says.

On the consumer side, the uncertainty of COVID-19 drew customers to digital-first credit options. BNPL firms like Klarna have boomed, offering instant credit for purchases at the point of sale. Responsible credit card providers like Tymit offer flexible lending options, letting customers choose which purchases carry interest and select their own instalment-based payment plans. 

“By doing away with revolving balances and minimum payments, online lending providers are giving consumers better transparency over what they owe, which is vital in these uncertain times,” says Johnson.

However, the growing popularity of online lenders is also forcing incumbents to address the shortfall in their services. A recent study found that, as banks ramp up their innovation plans, 91% say they need to improve their use of data analytics to gain insights into customers that will allow them to make lending decisions in real-time.

Furthermore, says Johnson, nine-in-ten banks believe they need to implement technology and processes that enable them to control what loans are spent on. With greater visibility and control, lenders can offer personalised lending options that will meet customer expectations, assess loan applications accurately, and reduce delinquency rates through bespoke spending restrictions.

He adds that in order to keep up with the swiftly evolving space, incumbents must embrace new technology and innovations fast. “To succeed, banks need to be supported with modern core banking and payment platforms, using an API-driven approach to help them develop and launch new digital products and services at pace. Time is of the essence, as those who can move quickly and double down on digital may be well placed to take advantage in a confusing, complex market.”

Financial well-being

Helander takes a different approach. She believes more than ever that incumbent banks must set the tone and focus on their customers’ financial well-being. To put it bluntly, she argues, investing in digital lending technologies is not the answer. 

“At a time when people are experiencing a great deal of financial anxiety due to the pandemic, banks have a duty to look after their customers’ well-being. They must focus on helping their users save money, invest it, and encourage them to be more mindful of their financial futures rather than providing more avenues into debt. And they need to act now, not in five years’ time.”

Helander acknowledges that this requires changing the mindset of an entire generation, “debunking the myth that borrowing money is a normal thing to do, and instead highlighting the importance of saving for long-term goals.”

She continues, “By placing financial well-being at the core of their strategy and implementing a customer-centric approach, which prioritises emotional engagement, banks will be able to develop financial tools that suit their customers’ needs, and crucially, that help them rather than hinder them.”

Helander isn’t against lending but says the manner in which it is done should be responsible and mindful of the dangers unhealthy debts and “the pitfalls of BNPL schemes” pose to borrowers.

She adds, “Crucially if customers recognise that banks genuinely care for their well-being, they will be more likely to prolong their loyalty to that bank. The number of young people that are encountering debt problems continues to grow daily, and one of the biggest contributing factors is the online lending revolution. If we do not act now, the impact on our economy could be detrimental.”

Online lending revolution drivers

Sankar Krishnan, Executive Vice President at Capgemini, Industry Head, Banking & Capital Markets, says,

• COVID-19: Covid-19 has been the greatest enabler of digital spending, with 80% of all transactions now digital, compared to the pre-covid era.
• Price: Fintechs are able to price loans much cheaper compared to traditional banks as they don’t have the “legacy effect of costs”. 
• Innovative Products: Online lenders have become innovative, with significantly reduced cycle times for a loan product at attractive repayment terms. This innovation includes the very popular BNPL deals announced by several fintechs, which have taken a dominant share of the market. 
• Digital Savviness: The overall growth of millennials as the largest segment of the economy, who prefer to be served digitally, has resulted in fintechs appealing to their needs on a personalised and customised basis with better UI/UX and better customer satisfaction.
• Growth of Data and Cloud: Thanks largely to AWS and Microsoft and the growth of Open finance, smart online lenders have found it easy to launch their better business models with friendly PEs supporting this industry like no time before in global history.

 FOUR ways to achieve financial sustainability

• Spend less, save more. Increase monthly savings and cut budgets where possible. Weigh up the pros and cons of new investments - and only opt for them if they are an absolute necessity.
• Only make affordable borrowing decisions. Avoid spending for an outward show or status symbol. Consider the loss to long-range goals in the ‘spend now’ mindset. 
• Get financially agile. Work with business advisors to restructure investments, finances and streamline working practices to cut down on wasteful spending.
• Protect what you have. Take out insurance for financials. Having cover that protects your business interests in the event of a crisis could be a make-or-break decision.

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