The maturity of the UK lending market

Open access to customer risk data should mean better customer choice and safer lending decisions. How will that change the financial landscape in the coming years? Joe McGrath investigates.

The British lending landscape is undergoing a transformation, the likes of which have not been seen since the years leading up to the global financial crisis. In both personal and commercial lending, new market entrants have been arriving weekly.

Low interest rates, increased competition and better technology have stimulated borrowing in all markets, not least in UK consumer finance.

“We have seen an increasing number of fintechs entering the personal loans market,” says Sarah Green, head of mortgages and retail banking at consulting group Sutherland.

“These are gradually eroding the market share of traditional financial institutions, as more borrowers turn to alternative lenders instead of banks. They are able to deliver a highly-automated, quick and streamlined process that requires significantly less engagement from the customer, going from application to estimated loan offer in just minutes.”

The growing popularity of new market entrants is certainly the case. But it is wrong to assume that the growth has come purely from alternative lenders. In recent years, underwriting criteria across the market have loosened as approaches to default risk have become more sophisticated. Technology has allowed borrowing decisions to be increasingly tailored to individual circumstances.

The source of the money behind the loans has also changed. Institutional investors have developed an appetite for these markets after asset managers stepped in to fill a gap left by banks when they retreated after 2008. Banks were licking their wounds after huge losses and had to navigate punitive cost implications of new regulations to prevent another crash.

Public money has also been finding its way into the market, not just through pension funds, but through crowd funding platforms and private funding sources. More recently, a handful of large brokers have evolved into lenders thanks to a return traditional warehouse lending lines, albeit not on the scale witnessed before the crisis.

 

Distorted picture

Figures from trade group UK Finance show that total outstanding consumer borrowing in unsecured loans grew from £29.8 billion in Q2 2013, to £35.3 billion by the same period in 2018.

While it would be easy to attribute the growth in the lending market to the innovations employed in the lead up to the UK’s Open Banking deadline in January 2018, the truth is that much of the growth in volumes is for other reasons.

However, that does not detract from the huge advances that the lending market has made in recent months. There is no doubt that the groundwork done to improve artificial intelligence, applications and consumer credit profile assessments is being translated into new approaches to lending.

“While the emergence of new fintechs has led to a smoother lending experience for many, Open Banking brings a huge opportunity to streamline that process further still,” explains Sutherland’s Green.

“Instead of customers having to upload necessary documentation, lenders will be able to access that information directly from the bank, reducing input from the customer to an absolute minimum.”
In the consumer market, there have been vast improvements in automated approvals for small, personal loans. Customers with easy-to-understand credit records can now see the instant transfer of funds to their bank account from organisations with which they don’t already have a relationship, thanks to better approaches to credit assessments and technology.

However, improvements in AI technology and credit record analytics are yet at a stage where they can offer the same service to everyone. In the specialist lending market, brokers continue to be frustrated by the wide range of service standards, meaning that pay-out times can be a complete lottery for many consumers.

Tony Sutton, a specialist lending broker with more than 36 years’ experience in personal loans and mortgages, says his clients want to know “how much does it cost?” and “when can I have it?” He says that the difference in sophistication between lenders is now vast, with the second-charge lending market especially far behind with development.

 

Why the delay?

Open Banking commentators say that the speed of transformation in this market may appear to be relatively slow, but much is being done to prepare lenders for the years ahead.

Particular attention is being paid to analysis of credit default risks, to be able to extend credit quicker, while simultaneously scanning competitors to ensure the best profit margin possible for the lender.

The groundwork being done now will effectively allow lenders to really analyse the customer, scrutinise their data, and have a better understanding of their propensity to default, says Green.

“This enhanced analytics capability could also lead to greater personalisation – for example, lenders could give customers added perks, such as a free coffee every month in what the data suggests is their favourite coffee shop.

“Alongside this personalisation is the potential for more relevant cross-selling. Data from the bank would reveal things like when the customer’s insurance is due for renewal, for example, so lenders would be able to target them with a better deal.”

 

Future developments

In response to the new market entrants and to forecast changes in economic conditions, legacy players are looking again at their lending approaches and how they assess customer creditworthiness.

Dave Tonge, chief technology officer at fintech Moneyhub, explains that lenders are increasingly realising that the customer experience is where they need to compete. He explains that this may mean that customers applying for a loan with one lender may be accepted but eventually receive their loan from a different provider, with the lender making a commercial margin by acting as a broker. Open Banking makes this increasingly possible and all at a speed which would seem relatively seamless to most customers.

Of course, the practice of passing customer ‘leads’ out the back door to third parties is not a new thing for lenders. In the days prior to the credit crisis, high street banks would pass customers who had been turned down for ‘prime’ lending, and who gave their consent, to third-party brokers to place these loans. While this process certainly wasn’t automated, or quick, it shows the commercial appetite for such a business model.

Tonge says that third-party tools will eventually look at customer finances and flag where there is a better deal, allowing them to switch to a lower interest payment at the touch of a button. “It is about showing people their eligibility in real time.”

Encouragingly, the competition in the lending market is not limited to small scale borrowing. It is also spilling over into the intermediated sector, benefiting customers that use brokers because of their specialist borrowing profiles.

The bridging, buy-to-let and development finance markets have all seen new entrants, with some offering impressive levels of customer service and technology. Specialist finance broker Tony Sutton says technology adopted by companies such as LendInvest and LendCo is setting the standard.

“Some lenders have really embraced new technology,” he says. “These two new lenders that entered the buy-to-let market in the past 18 months are good examples. With an application form automatically generated to the client, we entered the case as soon as the client submitted the form, and the lender was able to assess the case and pass it to valuation within three hours.”

 

Beyond personal loans

Innovation in the lending sector has also not been limited to consumers. Challenger banks and fintech market entrants have started to chip away at the monopoly of legacy players with their offers of instant overdrafts, short-term business loans and modern invoice finance alternatives.

“In the past two years, we’ve seen more alternative lenders emerging in the business finance sector, offering an increasing number of financial products,” explains Alastair Preacher, chief product officer at commercial finance broker Funding Options.

“These alternative lenders have focused on speed and convenience for customers, as they try to compete with the main banks on something other than price.”

A report from the Federation of Small Businesses, FinTech and market structure in financial services, published in February 2018, estimated total lending from fintechs and non-traditional sources accounted for £5.5 billion of all UK business loans extended in 2017. An assessment of the data by the Cambridge Centre for Alternative Finance was that this amounted to 29.2 per cent of all new loans to UK small and medium-sized enterprises (SMEs).

Given the potential size of the SME lending market, it is perhaps unsurprising that banks are now welcoming fintechs with open arms. Preacher says banks are becoming more vocal about such partnerships as they try to offer a greater number of services as part of their overall service to business customers.

“By having access to Open Banking data, fintechs and banks will be able to build more revolutionary products for customers, improving the features and services available to small business owners. Open Banking will continue to make the customer journey faster and easier, allowing more businesses to get funding and succeed.”

Tonge agrees: “When you are looking at invoice financing or bridging loans, it can sometimes be difficult to make these decisions because you need more data. But, with a richer level of data on transactions, these services will be easier to provide,” he says.