Author: John Hoffman
Loan origination — and, subsequently, loan origination software — is at an interesting intersection right now.
At a less institutional level, peer-to-peer lending is expected to grow at a CAGR of 53% between 2016 and 2020. But as lending technology matures, its impact could reduce profits in American banks by $11 billion per year, or roughly 7%.
This evaporation of margins is not a new problem for banks, though it is one that is increasingly disconcerting. In 2012, for example, the share of risk and compliance within general banking costs was 10%, a large portion of overall costs as they were. In 2017, risk and compliance are expected to consume 15% or greater. While costs are rising, it’s hard to actually mitigate risk with incremental risk management improvements. In large part, return on equity in banking often resides below the cost of capital, impacted by capital building projects and fines.
The result: to see increased growth into the next decade, banks are digitizing more processes. This has begun to happen, but a variety of studies — including many on millennial bankers — shows the digital transformation of financial services has not yet fully arrived. Since lending is a huge revenue source for banks across virtually all segments from small business to enterprise, making sure digital loan origination is properly executed is preeminent for many banks now.
As McKinsey has noted, the shift to increased digital transformation focus in financial services came about because of five distinct pressures (paraphrasing here):
- Changing customer expectations: Consider the rise of mobile and on-demand experiences.
- More regulations and risk-function effectiveness: Seen in increased regulations in most first-world economies, as well as more fines being dealt since the 2008 crisis.
- Data management and advanced analytics are hallmarks of competitive banks now: Buzzword or not, we are living in a Big Data era.
- Disruption: Risk management programs are essential for banks to compete with upstarts — if the upstart makes a big bet and misses, the established bank can favorably reposition.
- Increasing pressure on costs/returns: And as noted above, risk management doesn’t necessarily deliver in this way on the balance sheet.
As such, rapid-fire, on-demand loan origination programs and software have begun cropping up in the financial services world. Why? When risk decisions are made in seconds, loan origination cycles shorten for the customer. Shorter cycles create positive customer experiences, brand loyalty, connection to the bank and its relationship managers, and continued business. Speed can be good.
But, banks attempting a new approach to loan origination need more than speed. While quick risk decisioning and credit scoring is crucial, a loan origination software program also needs:
- The ability to process both structured and unstructured data: This would allow for the incorporation of both standard and alternative decisioning, i.e. credit documents vs. items from a loan applicant’s blog.
- Compliance: Perhaps the most important at the bank level, compliance calculation and True in Lending Act (TILA) disclosures need to be compliant, and documents must be in compliance with the Electronic Fund Transfer Act.
- “Look for initiatives within easy technological reach:” That’s advice from McKinsey above, and it makes good sense. Some loan origination software barely requires advanced coding anymore, so your IT side can work on more value-add internal projects.
There are other considerations such as ease to operationalize risk models that should be deployed.
Financial services, and especially loan origination have long suffered from a lack of transparency and simplicity. It oftentimes seemed that financial services firms were underserved by technology, or “square-peg/round-holing” the problem. That’s not the case anymore, and loan origination software and approaches are of huge value for established banks as a way to drive a growth culture forward. The crucial step is the right partner for your specific needs.