As Co-Group CEO at Target Group I’m often fortunate enough to have a front row seat to witness genuine innovation in financial services. Recently there have been some changes in the lending market in particular that seem to portent exciting times ahead.
In fact, right now we are in the most exciting period in the history of this market. The confluence, primarily of technology and regulation, but also of demographic change and funding presents extraordinary challenges and opportunities.
It is a market that has long been dominated by a few large incumbents but recent times have seen more and more challengers emerge with the aim of disrupting the status quo, and they seem to be making progress. Of course these challengers do have some notable disadvantages when compared to established players with a smaller operating scale, less opportunity for distribution, less data and less investment funding. However, David is closing the gap on Goliath and examples of where disruptors have changed the market are become more commonplace.
We don’t have to look outside financial services or the credit market to see successful strategies used by the likes of Capital One. Historically, pre the 1990’s, the UK credit card market was extremely limited with consumers offered only a handful of products and only through the major banks. Amazingly, Barclaycard, the biggest card issuer in the UK by far had only 3 products across their entire 12m+ cardholder base.
Capital One’s innovation was all about use of data. The company was an early adopter in using analytics to understand consumer spending patterns, and introducing products and offers best suited to the requirements of individual consumers. In a market of one size fits all Capital One brought mass customisation.
They were conducting tens of thousands of data experiments each year, offering credit cards with different interest rates, incentives, and marketing techniques all designed around their information-based assessment of the value-maximising approach for every individual consumer. The objective was to provide tailored offers to customers to motivate them to sign up while also managing the credit risk. And it worked. Their capability was so much smarter than the incumbents they were able to cherry pick the most profitable borrowers from the main issuers – cardholders who had too high an interest rate, too low a credit limit.
We’ve seen how these principles can be applied to great effect, but what are the key opportunities for lenders these days?
1. Design propositions around consumer needs
Across financial services the balance of power is shifting from providers to the consumer and expectations are rising. Lending has been run by the providers and the products have been designed to suit the providers. Traditionally the mainstay of personal loans has been an £8k loan paying down at say £200 per month over 5 years. I, the modern consumer, want to borrow on my terms. So why can’t I pay £200 per month for the rest of my life? Pay less when my credit risk profile improves? Or pay more if I want to gear up? Typically a consumer who takes one unsecured personal loan ends up taking five. Five products to meet one need? That suggests to me that the product design is wrong. Lenders need to rethink their approach to treasury, to pricing, to credit risk, to post-origination customer treatment strategies. Those who can do all this and thereby provide customer centric propositions can take substantial market share.
2. Use non-traditional data sources to understand customers
We are a long way into the digital revolution. The availability of data has ballooned at the same time as processing costs have shrunk. In that context one could expect that lenders approach to credit risk assessment and pricing must have transformed, but sadly it has not. Most lenders are using FICO and the main credit bureaux in ways that are not much different to a decade ago. There is growing evidence of lender’s increasing predictive power to assess the credit risk for prospective borrowers. They have the ability to separate the good from the bad using non-traditional data sources such as social media and application form completion styles.
3. Target underserved customers
There are niches outside of the risk appetite of the Big Banks that are credit worthy and substantial. Non-home owners have traditionally been avoided because of the flight risk. This population is growing as are house prices and lower max LTV’s on mortgages mean an increasingly large portion of society is renting for the long term. There is also a growing population of people with thin credit files (e.g. millennials) who do not fit standard credit models. Within these segments there will be a lot of consumers who would be a perfectly good credit risk. Some 93% of UK adults have a mobile phone. The mobile number has British lenders closer than ever to the elusive unique personal identifier, materially reducing flight risk, the biggest issue with lending to renters.
4. Understand existing borrowers
Incumbent lenders are making a disproportionate amount of their profit from their back books via existing borrowers. Many of these borrowers are on rates that are simply not justified by their credit risk. Whoever does in the unsecured personal loan market what Capital One did in the credit card market could end up reaping rewards.
The lender of the future will need to be brilliant and differentiate on a number of fronts. A superb understanding of the financial behaviour in the target segments, a huge focus on data analytics, strong skills on pricing and credit risk assessment and being proactive on top ups, renewals and restructuring will be vital as well as an understanding of what elements of the value chain they will keep in-house and what elements they will outsource. When we work with new lenders, one of the first discussions we have is about the elements of their value chain they’re going to be brilliant at. Once they know this, they can then dedicate their energy and resources to these, whilst working with a partner for areas such as the operational work, etc. Getting this mix right will be one of the keys to successfully challenging the status quo.
Download our White Paper on the Millennials' Attitudes to the Lending Market to discover how this age group is disrupting UK lending