Digital Lending: The Next Era of Banking
Commercial Credit, Small Business Credit, Enterprise Risk Management
I recently heard thought leader Rick Parsons outline a new theory on the history of banking, along with insights into the transformational forces shaping banking’s future. He had some insights that I’ll try to summarize below.
Across the board, conditions are good for bankers. However, as banking’s “Goldilocks” era – marked by upward growth momentum, low inflation, low interest rates, steadily rising asset prices and historically low financial market volatility – inevitably wanes, the banking industry will enter a new stage: that of digital lending. The wheels of transformation toward this new era are in motion, as banks invest in digitizing their systems, bringing in new talent and rethinking how they’re approaching their business processes.
Banks can’t afford to sit back and rest. Those that fall behind will get buried, and the smart ones are pushing to bring in new talent, implement digital systems and redefine their business processes. They’ll be the survivors who will outperform financially, and their return on equity (ROE) will be much larger.
A Look Back to Move Forward: Partnerships and Tech Innovation are Critical
Much of the sub-par economic growth after the 2007-2009 economic crisis was due to overly constrained lending as lack of access to capital held back the economy’s growth. Fewer constraints and a healthy banking system is key to a robust economy.
As we enter the next era of banking, banks that invest in digital systems and technology will be able to keep a lid on overhead while expanding offerings to target markets. Smaller banks, in particular, will have be able to achieve higher profitability, as digital innovations give them an opportunity to maintain a high ROE while maintaining low cost of funds (COF) and low overhead.
And, every bank should have a digital lending offering for small and medium sized enterprises (SMES). SMEs are a large market that is underserved by banks. For example, 99.7 percent of all U.S. businesses are private, and 48 percent of those are seeking credit. What those companies want are favorable loan terms and conditions, confidence in approval and fast decisioning – all achievable with digital lending.
A digital lending capability can be done relatively seamlessly and has the potential to add millions in shareholder value. Banks can retool outdated processes into digital lending to reduce time to decision from weeks to days increasing win rates by up to 30 percent and average margins by up to 50 percent. A recent McKinsey study showed that a bank with a balance sheet of $250 billion could capture as much as $230 million.
The BB&T merger with SunTrust is a testament to this new focus on digital lending. In the biggest banking merger in a decade, the two dominant banks surprisingly were in the same geographic markets. BB&T Chairman and CEO Kelly King directly cited competitive pressures around innovation as a driver for the merger, as regional banks feel the pressure to up their technology game. This might play out more and more, as banks look at all options for quickly building out their technology arsenals while gaining operational efficiencies.
What Will the Future Hold? No Amazon of Banking, More Customer-Focused Lending, a Continuing War for Talent, Consolidation
While we might see more M&A activity as banks look to optimize their digital lending offerings, the idea of a national bank is not likely anytime soon. The biggest banks aren’t necessarily delivering the highest returns, which means we won’t get the Walmart or Amazon of banking anytime soon. Niche players will thrive, with commercial and industrial (C&I) lenders achieving the highest risk adjusted ROE after farm lending.
Community and hometown banks, in particular, have a significant opportunity for growth, as they benefit from their proximity to customers. The outperforming community bank will embrace digital lending to lead as a different kind of bank. Tomorrow’s community banks will march into the future with a focus on digitization through investments and partnerships – all while keeping their customer relationships strong via great user experience.
In the future, the war for talent will only continue to grow, especially as data scientists are brought into banks to drive digital innovation. Banks will struggle to lure that new talent, especially as they compete with the likes of Google, Facebook, Amazon and other tech giants for recruits. Cities such as Austin, Charlotte, New York, San Francisco, Los Angeles and Chicago will become hubs for talent, so banks inevitably will gravitate there. And, banks will become more niche-focused as they look to differentiate themselves from the competition.
The number of banks have steadily decreased in the past decade. In 2017, there were 4,900; ten years ago, it was more than 7,000. Banks that engage in strategic partnerships with companies such as data and analytics firms and FinTechs will be at an advantage, as they will be able to supplement internal talent with external talent and counsel.
Possible curveballs include a sustained recession; leveraged lending run amok; government deficits crowding out capital access; and capitalism waning with a new generation of more socialist-leaning workers. However, even in light of these possible scenarios, we see a fascinating new period for banks – one in which those that see success will embrace the digital lending revolution.
Learn more about how you can ensure your bank is primed to take advantage of the digital lending era.