Back to the 1970s? Fintech lenders prepare for the future
Lenders are bracing for a tough year ahead as pandemic tailwinds ease along with high inflation and a host of related economic headwinds begin to gather. But some also see it as an opportunity.
Image source: Pexels/Andrea Piacquadio
While most agree they don’t want a repeat of the worst of the 1970s – winter power cuts, strikes, runaway inflation, bankruptcies, unemployment and sluggish growth – much of it already seems to be happening or should happen in the coming months.
For nimble digital lenders, especially those ready to react quickly to new data sources, however, this could be another period of accelerated growth following the gains made during the pandemic.
Lending may soon become a much more polarized market, with low-risk businesses and low-risk consumers still having abundant access to credit, but high-risk borrowers have pulled out.
The former will therefore be more strongly courted by a larger group of lenders. The latter, the opposite. Meanwhile, lenders will need a suite of new data sources to accurately assess the two groups. Fintech companies may well be best suited to these conditions.
Storm clouds collection
Normally, lenders are able to forecast their loans over a number of years based on the likelihood of a variety of outcomes. But now that time horizon has shrunk.
“Now things are changing quite quickly. And that poses challenges for lenders. But at the same time, I think it also brings high odds, not just taking it, the easy route of saying I’m going to stop lending to consumers just to play it safe,” Arie Wilder, COO of Auxmoney, one of Europe’s largest digital consumer lenders, AltFi told a webinar last week,
“At the same time, if you’re fast, have a testing mentality and are very analytical, and also take advantage of the power of additional data…then it’s also time to gain market share and to support these consumers in a responsible way with capital and at the same time, do good business,” Wilder said.
Although this scenario makes risks harder to calculate and therefore potentially more catastrophic, prompting some lenders to pull out of the market until the storm clouds disperse, Wilder says fintech lenders could have the advantage of taking new market share from incumbents.
“It’s just more uncertain. You need to think more about scenarios. You have to be fast and very analytical. And then I think it’s a period that can be successfully navigated,” he said.
Chris Keane of GDS Link, which provides credit risk tools to lenders, says many borrowers – both businesses and consumers are seeing an end to the distorting effect of the pandemic on their financial profiles.
“There’s a whole cohort of consumers who are really feeling the pinch of the rising cost of living and businesses who have seen their balance sheets flattered thanks to Covid support programs,” Keane said.
Katrin Herrling, CEO of Funding Xchange, says we’re starting to see failure rates for a cohort of SMBs increase after the “normal” signs you’d see for understanding business risk profiles become less muted.
This impact is coming to an end, with the end of government money and the effectiveness of the protection it gives to the corporate sector.
“We’re seeing – if you just look at the last two years as a lender – you may well feel like you’re operating in a very, very benign environment given the very low number of defaults. And even rates very low delinquency,” Herrling said.
“These risk signals are incredibly misleading…we can already see it in the very early warning signals, that we’re reverting to a much more conventional impact of risk on business behavior,” Herrling said.
The removal of support from government-backed Covid loan schemes for businesses and the unraveling of consumer savings reserves stored during the pandemic means we are in a new era for lending.
As a result, the next twelve months will become more difficult for lenders to assess SME borrowers, Herrling says.
“What we are seeing is that we are coming out of a period of great upheaval that has not played out like a normal recession due to very effective government interventions. We’ve seen two years where lenders’ portfolios have actually done incredibly well,” Herrling said.
“It’s the effect of around £87billion of funding being made available to UK businesses through loan schemes and then further support through other schemes that the government has also put in place. place,” she added.
Wilder says the same can be applied to consumers.
“We see that the economic recovery after the corona pandemic is now slowing down and that there are serious economic consequences for consumers. Mainly inflation and rising energy costs, which certainly puts pressure on customer affordability,” Wilder said.
However, he adds that the overall labor market points to a more robust environment in Germany, offering some hope.
“If you think about the consumer loan industry in Germany, although the situation is causing a lot more uncertainty than when you compare it to five years ago,” Wilder said.
A key question for lenders is whether to pull back from lending in these uncertain times. Lenders need to know which customers are at “good” risk and which customers are now most vulnerable when a full withdrawal is not an option.
Wilder says Auxmoney is “not backing down completely”. But is taking steps to lend more responsibly and protect investors’ returns by ensuring default rates don’t rise too steeply.
“So we’ve definitely looked at individual segments very carefully and also become more restrictive in certain segments where we don’t think it’s a good idea to give extra credit at this time,” Wilder said.
Many lenders are in a similar boat, unwilling to pull out of lending after two and a half years of the pandemic.
“We’ve seen the decimated portfolios of some of the largest digital lenders need to be rebuilt…by those who have been unable to use government programs to maintain the size of their portfolios,” Herrling said.
Indeed, the size of a lender’s overall loan portfolio determines its income. A complete withdrawal means going bankrupt.
“There is an economic reality, it is that having to deploy financing is also part of survival as a lender. I think the way it happens is everyone tries to find good companies to lend to and tries to find loan models that protect them,” Herrling said.
However, she says it has become much more difficult to access wholesale funding and this is restricting the supply of funding in the market. Due to a number of factors, this target segment of “safer” business loans is shrinking.
For households, borrowing is increasing. British consumers doubled their borrowing – mostly through credit cards – in June compared to May, from £900million to £1.8billion, according to the Bank of England. Second mortgages also appear to be back in vogue, with a 43% year-on-year increase in May, according to industry data, as households turn to debt to meet their bloated needs.
For lenders, a long-awaited higher interest rate environment comes at a time when demand for their loans is exorbitant, but that is marred by one of the toughest economic prospects in half a century. .
Whatever you play it, it gets amplified. business risks. Withdrawing from loans means losing income. Responsible lending also means losses. Some, however, also believe this can be a huge opportunity for fintech lenders to strengthen their market position in the medium term, despite this being their first experience of an economic downturn.