How banks can survive the creative destruction of the finance industry
By Martin McCann
Creative destruction is the essence of our economic system. Changes, both inside and outside an industry, continuously revolutionise the industry, destroying the old and creating the new. Think about music: in the last 60 years we have had six different ways to play music, starting with records, through the 8-track tape, on to cassettes then CDs, before moving over to MP3 files, and now online streaming. With each of these changes, companies have risen, become market leaders, and then fallen away again, their customer base taken by newer, more innovative rivals. Those that have survived have repeatedly adapted to stay relevant.
Those that don’t adapt find their value chains disaggregate as they become stale. Competitors attack bits of them, the chains start to break apart, and they reconstitute around different suppliers. This is what’s happening in the business lending market. New lenders and Big Tech have re-thought business lending, and of course they’re targeting the most profitable customers first. The value chain is on the move, and creative destruction is under way. It’s enabled by technologies including standardised software interfacing and cloud-computing resources, and the ongoing commodification of the internet.
Creative destruction of the value chain of the broader finance industry began more than three decades ago. In 1989 First Direct launched a phone and postal bank in the UK – with no physical branches. Internet banking in the UK began in 1997 with services launched by Nationwide Building Society and Royal Bank of Scotland; apps appeared when the smartphone was born 10 years later; and now as many as three-quarters of consumers use online banking in the UK, US and Australia.
Remarkably, the proposition to customers remains pretty much the same as it’s been for a hundred years or more: current or checking accounts, savings accounts, and secured and unsecured lending.
It’s the technology that has been changing – and particularly the way it’s used.
Yet few banks are using even a fraction of what the technology can offer for commercial lending.
Comfortable, familiar, compliant
They’re still using spreadsheets, email, manual storage, research reports assembled individually, and duplicated and mismatched customer data. Lenders who offer more than one product usually have completely separate systems and processes for each, despite this making it harder to cross-sell. They’re not using readily available data that could make their risk assessments more realistic. And they’re not taking advantage of automation, which could make it cost-effective to offer more complex products such as invoice finance.
The old systems are comfortable and familiar. They tick the regulatory compliance boxes. And to move away from them means investment and business disruption, even if the rollout goes smoothly. But they’re well past their sell-by date.
Why? Because of what they mean for customers: lengthy customer journeys, lots of errors and data mismatches, duplicated effort, and a lack of flexibility in dealing with the variety of risk that customers present. Typically it takes 30 hours for a customer to apply for a loan – if they even qualify to apply for one; error rates during processing of over 80%; and 90 days until initial draw-down. More than half of applications are abandoned.
These numbers are shocking. Why are banks willing to put up with offering this level of service?
New entrants are taking chunks out of the SME lending market, targeting the most profitable business. The Pareto Principle points to a loss of the most profitable 20% of customers translating to an 80% loss of value. Banks must do something different if they’re to remain relevant. If you don’t decide to be a winner, you’ll lose the profitable business.
Banks have lost whole markets to specialist entrants before
Specialist newcomers have taken whole markets away from banks several times in the past. Merchant cash advance (where a cash advance is paid off from a percentage of card payments) is one; foreign exchange is another. There are parallels in other industries – for example specialist insurers have taken segments of business, such as cover for domestic appliances and technology, from the general insurance giants; and in transport, ride-hailing has taken business from taxis.
Can Big Tech do better?
Big Tech thinks it can do better. Just a couple of examples: you can apply for a business credit card when you get to the checkout on Amazon, as part of the purchase journey – this is embedded finance. PayPal’s Pay in 3 is another embedded finance service where credit is offered at the checkout.
To see more clearly where value could be added, we’ll look at the value chain for bank business borrowers.
The value chain that customers see
A typical customer journey is something like this.
- Potential borrowers may start their journey at a website or app, or via an introducer or relationship manager – this is the bank’s distribution channel. It takes a few minutes to input basic information.
- Next the borrower registers and applies, and provides documents such as banking and accounting records. The bank processes the application, sourcing more information to check its sales suitability and for compliance, at which point a decision in principle is made. It takes the borrower several hours.
- The application passes through risk/underwriting and pricing processes. This takes a traditional bank weeks, or even months, to complete.
- The bank makes an offer and issues the documents for signature. It takes a week or two for documents to be physically transported, plus a variable amount of time for correcting errors that have been introduced by the bank, reissuing the documents, re-sending them and signing them.
- The borrower can draw down cash, and within the bank the account is handed over from origination to servicing – by copying and pasting between the origination and servicing systems – with the risk of copy/paste errors. By this point it’s three or four months since the borrower applied, and they’ve spent around 30 hours on admin.
- In servicing, the loan is monitored and managed. The bank reviews the account periodically, probably annually, and may cross-sell or upsell other products to the borrower.
The value that’s added (or deducted) at each point for the borrower comes largely from three factors:
- Whether the bank is willing to lend at all, since so few businesses in developed countries have traditional physical assets as security
- The effort required from the borrower in supplying evidence for the bank’s risk assessment, including correcting the bank’s errors
- The time spent waiting for the bank to process the application to decision and draw-down
Price sensitivity is not in the list. SMEs tend to value time-to-cash more highly than low prices. The risk they face is of their viable business going bust while they’re waiting for a loan.
How to add value
Every aspect of the value chain can be tuned, bringing competitive advantage and enlarging the addressable market for banks. It’s straightforward, and can be started now, at the pace that’s right for the individual bank – whether it’s a traditional bank that’s currently using 40 systems to support business lending, or a startup creating a bank from scratch.
As mentioned above, it’s about using technology effectively. The key is to have a platform that can organise and analyse information about borrowers – their borrowing requirements, evidence for how risky they are, what they’re borrowing, and adherence to the repayments schedule.
What good looks like
4 minutes to apply for a loan.
Under 1 hour to offer.
Under 1 day to cash.
A 50% reduction in back-office processing costs.
300% growth in revenue in 3 years.
This can all be done with a good business lending platform.
A platform brings together all the data needed throughout the customer lifecycle, provides analysis, automates processes, and shows at a glance the information that teams need to make good decisions. It supports all the bank’s processes, as well as applying its risk policies. It is flexible enough to support multiple products such as asset finance, invoice finance, term loans and embedded finance, enabling banks to launch new products quickly and profitably – and then cross-sell and upsell.
This is what the Trade Ledger platform does. It gathers all the information needed for business lending and takes it through your workflows. It provides support to your sales, business development, underwriting, legal and operations teams. The platform is modular and can be configured in many different ways, according to the products, processes, policies and preferences of your bank.
The new value chain
- The platform enables borrowers to apply on your website, or via your brokers’ websites. The details that the borrower types in go straight onto the platform. (The platform also handles signup for new brokers and broker management.)
- The borrower grants access to their banking records and accounting service (such as Xero or Quickbooks). There’s no need for them to find or supply any documents. The platform feeds in data from company registration and credit referencing sources. So far, the application has taken just a few minutes, all within a single journey on the bank/broker website.
- The platform presents all the information and analysis required, to the BDM, risk, underwriting and pricing teams. If the Risk Engine is being used, it provides an automatic risk assessment.
- The bank makes an offer to the borrower. There’s been no re-keying or copying and pasting, and the platform ensures that every team works off the same information, so it’s rare that there are any errors to correct. The offer goes to the borrower, who signs electronically. This can happen within an hour of the borrower visiting your website.
- The borrower gets their first draw-down and the account transfers to the Servicing team. This can happen on the same day as the application.
- The account can now be managed, accessing the same information that was set up in Origination. There’s no need to transfer any data into another system.
Migrating to a lending platform requires change, but it’s necessary to remain competitive against Big Tech and new lenders. Banks will be faced with the option of purposefully destroying their old to create their new, or eventually succumbing to new entrants who provide better service at lower prices. Trade Ledger can guide you through these changes. We’ve done it for several big names (which is how we know how quick and easy loan origination can be in practice).
And finally, why lenders need a single customer view
Do you know what your business borrowers are up to?
A single customer view (SCV) shows you all the key information about a borrower, in one place. There’s no need to check, say, your overdraft system and then your mortgage system to find out if a borrower has both. The SCV shows which of your products they have, and other information that’s useful such as how much they’ve borrowed and their repayment history.
The SCV also enables cross-sell and upsell. It’s common for business borrowers to get an overdraft, then a credit card, then invoice finance. Insights like this that can be gained from a SCV enable business development managers (BDMs) to target their market efficiently.
It enables continuous assessment of the quality of your lending. There’s no need to run annual reviews.
To find out more about what we can do for you, or to talk in more detail about lending products, security, technical details or anything else, drop us a line – we’d love to talk.
- Applying risk profiles: talk to us about our Credit Decision Engine.
- Big Tech and the threat to banking
- A deep dive into the challenges for SMEs: Revolutionizing the Digital Lending Value Chain