The role of lending platforms in an uncertain economy

The International Monetary Fund (IMF) has tempered expectations for growth, saying advanced economies in Europe and North America could see just a 1.4% increase in economic output next year. That gives rise to the prospect of a recession in the near future.

The consequences for lenders will be mixed: consumers turn away from mortgages in bad times, but the rising cost of living may prompt some people to take out short-term loans to cover day-to-day expenses. Consumers will always tighten their belts, forcing lenders to become more creative and more adaptable around the loans they offer.

“There is a general expectation that as economic growth slows, there will be a reduction in new lending and more focus on the quality of existing lending,” says Paul Randall, CEO of Creditinfo. “There will be increased pressure on what people can afford to do – for example pay their mortgages – especially when household budgets are under pressure.”

In challenging times, “affordable is the name of the game”

“Affordability is the name of the game during an economic crisis,” says Randall. “If people can’t afford to repay their loans, lenders will inevitably tighten up on risk and reduce new lending. However, granting loans should never be a black-and-white decision – not least because this underserves consumers and has a negative knock-on effect on the economy, as the flow of capital is consequently reduced.

“Other options, such as the flexibility to adjust repayments or offer a smaller loan instead of none at all, will ensure customers are served without overburdening them.”

“There will be a need to support people who find themselves in financial difficulties,” agrees Neil Kadagathur, CEO and co-founder of fintech lender Creditspring. He suggests making sure the loan costs are clear in advance; take a step back on late fees; and keep track of changes in consumers’ financial situation, especially where it forces them to take out more than one short-term loan.

“There will inevitably be a proportion of customers who will struggle to repay loans as economic growth slows and wallets tighten,” Creditinfo’s Paul Randall continues. “In the meantime, lenders will do everything they can to reduce the risk profile.”

Embrace open banking to improve credit decisions

Tougher economic conditions will make it critical for lenders to make reliable credit decisions. With many household budgets under increasing pressure, ensuring that borrowers can repay their loans will become more important – and data has a huge role to play.

“Proper risk management is about capturing as accurate a picture of a borrower as possible,” explains Randall. “The quality of the information used in this process is extremely important.

“In times of strong economic growth and minimal losses, lenders become more confident in lending. When the economy slows down, the focus should be on performing rigorous checks and building airtight target borrower profiles to build holistic and objective overviews that will help reduce potential risk.

“The second aspect lenders can focus on is continuous, clear communication. Neither borrowers nor lenders want to see customers fall behind on payments, so it is very important to encourage lenders to conduct an open dialogue with borrowers to discuss their issues, and removing barriers to this open communication is key. For example, banks must try to ensure that stressed borrowers in times like this are not waiting for long periods to speak to someone.”

Tasha Chouhan, UK & IE Banking Lead at Tink, agrees: “Financial service providers should embrace the use of open banking technology to enable faster and more accurate real-time credit decisions that work for everyone. Greater access to financial data allows lenders to make better decisions about affordability and creditworthiness, based on up-to-date income and spending information rather than credit scores or outdated risk decisions.”

How can lenders win consumer trust in these difficult times?

There is an argument that short-term lenders – especially buy-now-pay-later (BNPL) – have lost their halo post-Covid. Creditspring’s Neil Kadagathur claims that many BNPL customers did not understand the implications of falling behind on repayments, with almost half of respondents to a survey unaware that they could be referred to a debt collector for missing a BNPL payment. It is a worrying state of affairs. Recessions have a way of creating the unfortunate illusion that lenders are profiting from the desperation of hard-pressed consumers.

“Traditionally, there has been a widespread distrust of lenders and this is still the case,” explains Kadagathur. “Unfortunately, the lending industry has often been seen as focused on profits rather than customer welfare – over four in ten (43%) believe lenders encourage them to take out more money than they can afford, and fewer than one in five (17%) see on lenders as responsible businesses that care about their financial well-being.

“Over the next few months, lenders are likely to see increased applications from borrowers due to the cost of living crisis – and the focus from lenders should be to ensure they are offering the right support. Strict price controls are essential to protect borrowers and ensure they do not over-borrow, which which puts borrowers at increased risk of debt. For this, an integrated technology approach using open banking services to review financial information with the borrower’s permission can ensure more accurate and faster decisions around borrower affordability, streamlining the process but also providing more support to borrowers on a time they need it most.”

Paul Randall continues: “During an economic downturn, the borrower profiles that lenders target will be limited, so lenders must do everything they can to collect as much relevant data as possible to keep the pool of target customers as broad as possible.”

He warns that lenders must either become more cautious or transfer the risk to borrowers: “A trend we have seen before during economic downturns and recessions is that larger financial institutions tighten their risk profile and make fewer loans, while smaller financial organizations may try to prioritize the customer experience by not push down as hard, but charge more for repayments in an attempt to reduce the additional risk.”

Whatever approach they choose, lenders need to do something to show willingness and play their part in any financial crisis, as Neil Kadagathur argues: “The industry needs to work more closely with external stakeholders … to increase financial education, lend more responsibly and improve transparency. All these steps will provide more support for borrowers at a time when many people’s finances are under pressure.”