The financial crisis of 2008 has shaped so many aspects of the financial world. Part of that legacy has been the significant impact on the way in which banks lend money. Today, banks sell few unsecured personal loans to new customers - of seven of the UKs tier one banks only two offer personal loans to new customers - instead focusing on the needs and data of their own clients. The establishing credit risk and difficulties of pricing accurately has simply made it too complex to be competitive. Customers have to submit lots of evidence – all of which leads to frustrating experience; for example to even get a quote for a personal loan from one of the tier one banks surveyed, the customer must submit address details for the last three years, as well as employment, income, and existing credit details. By-and-large, your own bank will be easier and cheaper – unless you have specialist needs; for example if you have a poor credit score.
An alternative option open to customers is peer-to-peer lending. However, a comparison of the process from a tier one bank to the equivalent in a peer-to-peer lending provider reveals a slower standard application turnaround time (up to three days) or an option to “fast track” the application for a fee. Also, although many peer-to-peer lending sites now have better protection for consumers as the industry became regulated by the FCA in April 2014, it can be argued this protection is greater for savers and lenders than it is for those borrowing and that the industry is still high-risk when compared with traditional routes.
This could all be about to change with the introduction of the intertwined The Second Payment Services Directive (PSD2) and open banking regulation. With the implementation of the Access to Accounts (XS2A) rule, banks will soon be able to access customer account data from other financial institutions. In the UK, even with Brexit looming, the principles of open banking will be adopted – enshrined in UK regulation set out by the Competition and Markets Authority and enabled by the Open Banking Implementation Entity. This will be a seismic which will come with several opportunities and risk. The full consequences of these changes remain to be seen but some implications are easy to see.
First, XS2A will significantly improve the customer experience for loan applicants. Customers will no longer need to provide information on earnings or outgoings, for example. Instead, standard/semantic application programming interfaces (APIs) will be called, providing data directly. This will cut the average time it takes for a customer to complete a new to franchise lending application to the speed at which the data can be transferred between banks – it could seem close to instant from the consumer’s perspective. This will radically reduce dropout rates.
The key in innovation
By gathering data automatically, lenders will be gathering more accurate and comprehensive data. This will mean that potential bank lenders will be able to understand as much about new customers as their existing ones. Manually gathered data – especially for income and expenditure, is notoriously inaccurate. This has two benefits; the first is that is reduces the number of referrals and the need to go back to the client for clarifications. In turn, this reduces the cost and turnaround time of the application and improves the customer experience. Secondly, by improving the quality of the data gathered, the risk of the potential loan can be more accurately assessed. This means the bank is able to make more informed credit decisions. As a result, a more sophisticated pricing model can be deployed, so banks can offer more competitive loan rates to new customers, which will in turn help to increase applications.
So far so good – but XS2A will bring some significant threats to bank lenders. Most obviously, all the opportunities that banks gain access to will also be available to their competitors. It will be as easy to be poached from by other banks, as to poach their customers. More significantly, there is the risk posed by new entrant, who for the first time will be on a level playing field with the banks. With few legacy systems and no existing margins to protect, these new entrants have the potential to seriously disrupt the market. New players like Atom Bank and Monzo Bank in the UK have already started this process – which will only accelerate after PSD2. There are also ways in which sites like MoneySupermarket can use account APIs to help customers to compare deals more easily – which poses another threat to bank margins.
To combat these risks, banks will need to invest in their lending capabilities across a range of factors. First, banks will need to optimise their lending processes to compete with the new to market disruptors. Banks need to focus on non-documentary, mobile first apps that minimise customer drop out. To enable this, they will also need to improve their automated data gathering from credit bureau and other data sources, such as the Driver and Vehicle Licensing Agency or by deploying optical character recognition for driving licenses, which can be validated by customer selfies. Similarly, customer support needs to be integrated seamlessly into application processes to help customers with any queries. This could be a combination of messenger apps, chatbot, or even video chat.
Lending product features will also need to evolve in an effort to become more competitive. More features can be added – for example, payment holidays could be offered as a payable option or suggesting flexible monthly repayments which move up or down depending on the customer’s current balance.
Banks will need to underpin all of these new services with improved analytics which will enable them to better process the significant volumes of new data into new products and services. In fact, banks have a head start on many new entrants when it comes to creating a financial hub, given the huge amounts of data they already hold. The key will be for banks to be willing to innovate in order to seize the many opportunities that PSD2 provides.