The lending world in 2024 is feeling the pressure from two big forces: the economy and technology. We’ve experienced a slow burn in the economy going back to the pandemic fueled infalation. As folks worry about a potential economic downturn, lenders are doing some soul-searching, rethinking their lending rules and keeping a close eye on the playbook. On the tech side of things: big data, machine learning and AI is elbowing its way into corners where it’s never been before, although there are a few kinks to work out before it becomes the norm.
Lending in the Face of Economic Uncertainty: During rocky economic times, lenders often switch gears to manage risks and keep their profits flowing. With online lending on edge due to looming economic challenges, we’re spotting some trends and tactics that could become the new normal in consumer and business lending:
- Stricter Borrower Requirements: Lenders might get a tad more choosy when it comes to approving borrowers. They could up the ante by raising minimum credit quality / score requirements.
- Scaling Down Loan Sizes: To keep risks in check, lenders may offer smaller loans. This way, if a borrower defaults, the losses won’t be as painful. Personally, I’m dubious on this strategy since the cash flow is way more important.
- Bumping Up Interest Rates: Lenders might hike up interest rates to balance out the added risk that comes with lending during shaky economic times. This move keeps their profits intact. It’s also a good time to rethink how they calculate those interest rates. Not to mention, the lending supply and demand curve can start to lean towards the lender side, so pricing pressure eases due to a lack of lending alternatives. We saw this during the pandemic where lenders closed shop while pandemic and unemployment funds were booming.
- Stress Tests: Lenders may put their loan portfolios through some stress tests to see how they’d hold up during economic turbulence. This helps them spot any weak spots and take steps to prevent losses.
- Focusing on Loyal Customers: Lenders usually like to keep a soft spot for customers who have a history of paying up. This is the same as avoiding new customers who do not have payment histories with the lender.
Although there’s a recession looming on the horizon, it hasn’t hit us with full force yet. So, the strategies lenders use will depend on how bad it gets, the lender’s size, the industry they operate in, and the rules they have to follow. Government policies and stimulus programs can also shake things up.
Navigating Risk in Lending: Now’s not the time for lenders to let their guard down. Online lenders need to shore up their defenses against risk, fraud, and sloppy lending. Lenders consider different types of risk when they lend to consumers and businesses:
- Employment Risk: What happens when the workforce gets trimmed 15%? It’s unrealistic to think borrowes can pay you, if they’re not working. During the pandemic, there were recession proof industries, like healthcare, public service, education, utilities and financial services. What are the recession proof industries and what are not, like construction, retail, auto, vacation related?
- Default Risk: This is the basic risk that a borrower might not pay back their loan. It’s linked to their credit history, financial stability, and their ability to repay.
- Credit Spread Risk: This is about changes in interest rates and how they affect the value of a credit instrument, like the Fed rates. Online lending is mostly driven by investors and if their personal loans are being called that will inevitably trickle down to their investements.
- Concentration Risk: This pops up when a lender puts too much money into one state, and then things go south in that state.
- Liquidity Risk: This is all about borrowers not having enough cash to meet their short-term financial needs, making it hard for them to repay loans. It’s logical that a borrower will pay their rent before they pay their loan payment.
- Institutional Risk: This risk happens if there’s a breakdown in the legal or contractual setup between a lender and a borrower. Just like choke point, a cataclismic event can happen.
Good underwriting is a must for lenders to make wise decisions. Lenders should keep an eye on their loan portfolios, making sure borrowers are still reliable. This means they need constant access to credit and performance data.
The ultimate litmus test is can my lending portfolio handle a decline in originations or degradation in performance and to what degree?
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