In an Uncertain Market, Count on Data

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Against a backdrop of challenging macroeconomic risks, including inflation, potential recession and high interest rates, banks are also dealing with volatility connected to the collapse of three regional banks. These are difficult times, especially for financial institutions.

At the same time, banks are struggling to achieve primacy: being the go-to for their customers’ financial needs amid the marketplace of more agile fintechs. To do this, banks need to make smart decisions, fast. This amalgamation of business-impacting factors might seem like an unsolvable puzzle. But in an uncertain market, banks can leverage data to cultivate engagement and drive primacy.

Banks can count on data, with some caveats. The data must be:

  • While there is a massive amount of data available, banks often lack a complete picture of the consumers they serve, particularly as digital banking has made it easier for consumers to initiate multiple financial relationships with different providers to get the best deals. It’s vital that banks get a holistic view of all aspects of a consumer’s financial life, including held away accounts, insurance and tax data.
  • Increased open banking functionality empowers consumers to take charge of their data and use it to be financially fit. Open banking serves that connectivity and makes it more reliable.
  • Banks are flooded with data, the torrent of which makes it difficult to extract value from that data. Up to 73% of data goes unused for analytics. But the right analytics allows banks to reduce the noise from data and glean the necessary insights to make decisions and attract and retain customers.
  • Most transaction data is ambiguous and difficult to identify. Banks need enriched data they can understand and use. Data enrichment leads to contextualized, categorized data that gives banks tangible insights to improve their customer’s journey and inform more meaningful interactions.

Data as a Differentiator
Once banks have high quality data, they can use it to differentiate themselves across three key areas:

1. Make smart, fast customer decisions.
Banks are expected to deliver relevant offers at the right time to customers before rapidly making critical risk decisions. The ability to do this hinges on having a holistic view into the totality of a customer’s bank accounts. Data science algorithms using artificial intelligence and machine learning can then surface insights from that data to engage, retain and cross-sell via personalized, proactive experiences. From there, banks can execute for growth with rapid integrations that help gain wallet share and productivity.

2. Promote financial wellness.
Banks are nothing without their customers. To win and keep customers, banks need to provide tools and products that can enable an intelligent financial life: helping consumers make better financial decisions to balance their financial needs today and building to meet their aspirations for tomorrow. One way to help them with this is to provide a holistic view of their finances with account aggregation and money management tools. According to a recent survey, 96% of consumers who used financial apps and tools powered by their aggregated data were more likely to stay with the financial institution providing these tools. These tools give banks a way to helping their customers and inspire loyalty.

3. Forecast and manage risk.
Uncertainty over recent events in the banking industry has made the need for immediate insights into net deposit flows an imperative. Banks can use aggregated data to identify, forecast and manage their risk exposure. Digital transformation, which has been all the rage for years now, can enable centralized holistic views of a bank’s entire portfolio. Dashboards and alerts make it more practical for bankers to identify risks in the bank as they develop. A platform approach is vital. Banks need an entire ecosystem of data, analytics and experiences to mobilize data-driven actions for engagement, retention, growth and ROI.

Now more than ever, banks rely on data to cultivate engagement and drive primacy. Starting with holistic, high-quality data and applying analytics to derive insights, banks can drive the personalized consumer experiences that are necessary to attract and retain customers. And they can use that same data to better forecast and manage risk within their portfolio.

Modernizing Business Lending to Drive Growth

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Digitization has altered the business lending landscape and created competitive pressure that will continue to push solutions modernization — and consumers and businesses are ready.

Digital efficiency here is key and underpins lending success. Most importantly, it improves consumer retention, upsell, and cross-sell opportunities for lenders. As the future of business lending caters to the needs of younger entrepreneurs, financial institutions will want to add solutions that offer seamless experiences. This includes a fully contactless digital lending process: seamless digital applications all the way to fast, automated loan decisions. Financial institutions can jump-start and grow digital business lending by implementing advanced technology solutions to digitally engage borrowers and optimize lending processes.

Digital-First Mindset Drives Growth
Millennials are the largest drivers of new loans. This makes sense considering there were more than 166 million individuals under the age of 40 in the U.S. in 2020 — more than half of the U.S. population.

Financial institutions are feeling the pressure all around. Digital banking reigns supreme as consumers increasingly prefer to manage their finances digitally and loyalty is waning. Institutions need to offer innovate lending solutions and reconsider how they engage consumers. Already, digital-savvy financial institutions are scooping up this business. According to the Bain Retail Banking NPS Survey, 54% of loans and 50% of credit cards in the U.S are opened at providers that consumers do not consider their primary financial institution. And more than three-quarters of those surveyed who received a direct offer from a competitive institution said they would have purchased from their primary institution had they received a similar offer.

As more and more lenders provide digital-first experiences, consumer expectations have evolved. Processes that used to take days can now happen in minutes. Technology has decreased the operational effort required of financial institutions and enables demand creation, so institutions can reach new consumers and foster deeper relationships with existing ones.

Pressure to Modernize Business Lending Solutions
Institutions that have not modernized business lending processes are feeling the pressure. Those that still rely on manual and paper-based loan approval procedures find they are out of step with a digitized world, affected by:

  • Slower decision times.
  • Burdensome data management.
  • Time-intensive manual processes that span disparate systems.
  • Inefficient application processes and communications with the borrower.
  • Expensive wet signatures.
  • Difficult document collection, management and storage.

The cumulative effects of these inefficiencies are compounded by the evolving landscape in lending. Nearly nine in 10 financial institutions believe they will lose some business to stand-alone fintech companies over the next five years. That fear is not unfounded.

Managing Credit Risk in a New Era
The business credit framework has not changed. Lenders still consider credit profile and history, firmographics and cash flow analytics when evaluating debt capacity. This requires the ability to collect and analyze data like macroeconomic factors, industry trends, digital presence, credit performance, financials, bank accounts, POS transactions and business credit reports.

Solutions to manage risk, however, have modernized. Advancements in machine learning techniques have transformed risk analysis to consume thousands of data points and leverage insight and learning from decades of loan performance data. For business lenders, this means better, faster, more accurate and consistent decisions in compliance with the set credit policy. Digital-first lenders can:

  • Use superior workflow tools to aid in better decision-making and operational resiliency.
  • Leverage risk assessment techniques that cannot be performed by humans.
  • Improve accuracy and consistency of credit decisions.
  • Specialize and customize by industry based on business goals.
  • Leverage new data sources and decades of credit performance data.
  • Process large volumes of data in seconds alongside the ability to identify and focus on what matters most.

Financial institutions transitioning to digital channels enjoy more opportunities to better serve consumers, expand market share and drive more revenue.

Lessons Gleaned From Bank Failures

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The postmortem regulatory reports on the failures of $209 billion Silicon Valley Bank and $110 billion Signature Bank are an emphatic reminder of the consequences of poor risk management.

Among the specific circumstances that contributed to their closures in spring 2023 is how their boards and management teams failed to effectively manage several core banking risks, including interest rate, liquidity and growth, according to reports from the Federal Reserve and the Federal Deposit Insurance Corp. The official reports confirm recent media reporting that indicated surprisingly lax risk management practices at the banks, both of which were some of the largest in the country. Community banks that may see themselves as having little in common with these large institutions can still glean insights from the reports — and perhaps, avoid their fates.

Santa Clara, California-based Silicon Valley Bank’s “rapid failure can be linked directly to its governance, liquidity, and interest rate risk-management deficiencies,” the Fed wrote. And the FDIC found that New York-based Signature Bank had weaknesses in “liquidity contingency planning, liquidity stress testing, and internal controls” that figured “prominently” in its failure.

Interest Rate Risk
“While interest rate risk is a core risk of banking that is not new to banks …, SVB did not appropriately manage its interest rate risk,” the Fed wrote. 

The bank’s interest rate risk (IRR) policy — which detailed how the bank would manage and measure interest rate risk — was vague. It didn’t specify which scenarios to run, how to analyze assumptions, how to conduct sensitivity analysis and it didn’t define back-testing requirements. The bank used “the most basic” IRR measurement available, despite its size.

Still, its models indicated the bank had a structural mismatch between repricing assets and deposit liabilities; as early as 2017, it identified breaches in its long-term IRR limits, the Fed wrote. But instead of addressing the “structural mismatch” between longer duration bonds and demand deposits, the bank adjusted its model to get better results.

“I lose count of the number of cognitive biases that got activated in their process — from confirmation bias and optimism bias to so much else,” says Peter Conti-Brown, an associate professor of financial regulation at The Wharton School at the University of Pennsylvania. “It is the most common story ever told: When you make big goals, you then try to rough up the ref so that you can get the outcomes you’re seeking. The ref in this case is basic bank accounting.” 

Additionally, Silicon Valley executives also removed interest rate hedges that would’ve protected it from rising rates, a move the Fed attributes to maintaining short-term profits instead of managing the balance sheet. 

“That’s more casino behavior than it is prudential behavior,” says Joe Brusuelas, chief economist at RSM US LLP. “It’s throwing the dice at a casino.”

Liquidity Risk
Both banks had an unusually large percentage of accounts that were over the $250,000 deposit insurance threshold, the withdrawals of which acutely contributed to their failures. 

“Uninsured deposits are considered higher risk as they are more prone to rapid runoff during reputational or financial stress than insured deposits,” the FDIC wrote. But Signature’s management didn’t develop a funds management policy or a contingency plan, in part because they didn’t believe those customer deposits would become volatile. 

“[Signature’s p]resident rejected examiner concerns about the stability of uninsured deposits as late as noon EST on March 10, 2023,” the FDIC wrote. New York regulators closed the bank on March 12. “[M]anagement’s lack of a well-documented and thoroughly tested liquidity contingency plan and its lack of preparedness for an unanticipated liquidity event were the root cause of the bank’s failure.”

Both management teams had assumptions around their deposit base that “just weren’t true” Brusuelas says. He adds that bank management teams now should reexamine their analytical framework around their liquidity risk management and strengthen governance policies and limits around their deposit mix.

The FDIC wrote that funds management practices should lay out how a bank will maintain sufficient liquidity levels, how it will manage unplanned or unanticipated changes in funding sources — like a number of large accounts withdrawing and how it will react and withstand changes in market conditions. The practices should also incorporate the costs of the backup liquidity or source of the liquidity, both of which may change under market stress.

Backup liquidity is crucial in times of stress. Silicon Valley Bank didn’t test its capacity to borrow at the Federal Reserve’s discount window in 2022; when the run started, it didn’t have appropriate collateral and operational arrangements in place to meet its obligations. 

Growth
“The fundamental risk of too much growth too fast is a failure of diversification,” Conti-Brown says. “Rapid growth comes [from] a sudden influx of funding … that goes into a small number of asset classes.” 

Both reports discuss how already-weak risk management was further exacerbated when the banks experienced rapid growth; risk management and control policies failed to increase in sophistication as deposits and assets grew. And neither bank seemed to revisit the appropriateness of risk management, governance and internal audit policies nor whether their boards had experience levels commensurate with the institutions’ new sizes as they grew.

Silicon Valley Bank’s growth “far outpaced the abilities of its board of directors and senior management,” the Fed wrote. “They failed to establish a risk-management and control infrastructure suitable for the size and complexity of [the bank] when it was a $50 billion firm, let alone when it grew to be a $200 billion firm.”

The reports make a compelling argument that active and constant risk management plays an important role in the long-term financial solvency, success and continued operations of banks. Boards and executives at institutions of all sizes can learn from the risk management failures at these banks and revisit the appropriateness of their risk management principals, policies and models as the economy continues to shift. 

“The goal of risk management is not to eliminate risk,” the Fed wrote. “but to understand risks and to control them within well-defined and appropriate risk tolerances and risk appetites.”

Risk issues like these will be covered during Bank Director’s Bank Audit & Risk Conference in Chicago June 12-14, 2023.

Evening the Score for Small Business Lending in a Down Market

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Small and medium-sized businesses (SMBs) are vital components of our local communities, yet they often face difficulties accessing the capital they need to operate. At the same time, community banks want to support their local SMBs but may hesitate to underwrite small business loans, especially for small dollar amounts.

All this is compounded during times of economic stress and uncertainty. The knee-jerk reaction of most banks is to tighten their lending standards and narrow the credit box — no surprise, given that banks historically face challenges in providing small dollar financing, even in the best of times. The reasons for this are myriad: on average, small loans tend to have a loss rate that is double the rate of larger loans, climbing even higher during bad economic times. Operating costs for small dollar loans are also an issue, as most lenders must scale down these costs by more than six times on average to achieve the same efficiency as their larger loan products.

So where can bankers and SMB owners find a balance that works for both? For banks, it is about balancing credit risk parameters while providing needed liquidity to small businesses in their communities. That work begins with access to richer data sets paired with newer, better expected loss credit models specifically designed for the challenges of small dollar small business lending. This level of intelligence can help bankers make more informed credit decisions faster, potentially reaching more borrowers and growing loan portfolios, even as competitors curtail their own lending programs.

The Limitations of Traditional Credit Scoring
While FICO scores are important and proven tools, the bulk of their data is still geared more towards individuals rather than businesses. Business bankers should leverage new alternative credit models that offer a better analysis of expected loss for SMBs and significantly better insights to support small dollar lending. Used in conjunction with traditional FICO/SBSS scoring, this new model enhances the credit view for banks and offers information well beyond the behavioral score, including macroeconomic, business, franchise and other important data.

An expected loss model is an additive component of a bank’s credit decisioning and augments other existing, traditional data sources to offer a much more comprehensive view of the borrower. This helps bankers better mitigate risk and provides further insights that could support an expansion of a bank’s existing credit risk appetite.

Incorporating both consumer and business credit data that is enhanced by other relevant economic and business factors, banks can gain a much more complete picture of their potential small business borrowers beyond the consumer credit score alone. Often, SMB borrowers with similar consumer credit scores can present vastly different risks that may not be easily seen, even within the same area or industry.

For example, two restaurant owners may appear very similar in terms of risk just looking at their FICO scores. However, a deeper view of the data may show that one has been operating for over 10 years in an metro area with low unemployment, while the other has been in business for less than a year in a city currently experiencing much higher unemployment rates. Likewise, differing FICO scores might not tell the whole story. A business owner with an 800 score may be in a more volatile industry or located in a city with extremely high unemployment or poverty rates, while an owner with a lower score may be experiencing the opposite.

Additionally, this enhanced data approach can help banks more effectively meet lending and/or financing mandates tied to environmental, social and governance (ESG) values, as more robust data enables banks to better reach underserved borrowers who may not meet traditional/standard FICO criteria. This has the potential to open up new markets for the bank.

Successful SMB lending does not end at origination, however. This richer data provides bankers with enhanced risk management capabilities over time, allowing them to continuously monitor their lending portfolios as they move forward or even run them on a “look back” basis. Banks can leverage technology solutions and platforms that offer advanced analytics and predictive modeling capabilities to better manage their small business lending portfolios to achieve this. These solutions can help banks detect early warning signs of potential defaults or other risks, allowing them to take proactive steps to mitigate those risks before they become larger issues.

Small and medium-sized businesses play a critical role in local economies; supporting their growth and success is essential. Leveraging new credit models and richer data sources allows banks to more effectively manage the risks associated with small dollar lending and expand their lending programs to reach more underserved SMBs in their communities. Doing so allows them to help level the playing field and provide much-needed liquidity to these businesses, enabling them to thrive even in challenging economic conditions.

What Banks Can Learn From Credit Unions

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In today’s highly competitive market, community financial institutions are doing everything they can to stand out and grow. This is always a challenge, especially given the complexities of commercial and business banking.

Credit unions have been a traditional competitor of community banks, typically focused more on retail customers rather than business banking. Many credit unions often have tools in their arsenal that give them a significant competitive advantage: credit union service organizations, or CUSOs. CUSOs are client-owned cooperatives that give institutions control of specialized companies that provide them with personnel, marketing support, technology and a wide range of other products, services and benefits.

Increasingly, more forward-thinking community banks are adopting a similar strategy to better compete and thrive in their local markets — and realizing some key strategic benefits along the way.

Better Technology
More robust and newer technology is one of the key advantages that larger banks typically have over smaller institutions; sharing the development expenses and saving on configuration costs gives community and regional institutions a way to level that playing field.
This gives institutions access to innovative technology and needed resources that they might not otherwise be able to afford. Banks can realize many benefits from today’s technology and get a better view of what may be coming next.

One of the biggest challenges that many community banks face is the inability to capitalize on emerging technology trends — even when they can see them coming. Most institutions are at the mercy of their technology partners and vendors, that in turn tend to focus on the needs of their larger bank customers. A cooperative, by comparison, can respond to the needs of all its clients, giving each of them a voice in the future development of their tools, regardless of asset size.

Having a seat at the table is an invaluable benefit if a bank realizes it needs to alter its workflow or implement new back-office processes. Instead of waiting on a technology partner to find time to discuss the changes, cooperative clients have access to dedicated experts who can prioritize their needs.

All-Inclusive Access
Community bankers recognize that while having access to technology and innovation is a key competitive advantage, knowing how to properly leverage that technology is even more critical.

Banking cooperatives can give bankers direct access to best-in-class technology like secure, cloud-based loan origination platforms and systems, pairing that with access to experts who can help their clients fully understand these solutions to generate the greatest return.

Cooperatives can also provide access to skilled professionals across a wide range of specialties, including underwriting, marketing and call center operations. This is especially valuable in today’s marketplace, as recruiting qualified talent has become even more challenging.

Additionally, most cooperatives offer access to group purchasing. This can save clients a significant amount of money on everything from software, computer equipment and hardware to office and break room supplies.

Innovating Together
One of the biggest advantages that cooperatives offer financial institutions is the ability to bring together a community of like-minded, forward-thinking peers that foster and promote innovation. The cooperative structure allows credit unions — but also banks — to share best practices and take a more direct role in how they help develop and implement new technologies, while having an ownership stake in those products and services.

Today’s banking landscape is more crowded than ever; with technology evolving so quickly, it can be difficult and costly for community banks to stay on top of these changes while competing effectively against larger institutions.

A well-designed banking cooperative can offer community banks a way to share benefits in the same way that many credit unions have long enjoyed, through access to the best technology and the collective wisdom, insights and experience of a cooperative community that provides the tools and support they need to grow and succeed.

This piece was originally published in the second quarter 2023 issue of Bank Director magazine.

Finding Fintechs: A Choose Your Own Adventure Guide

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In my role as editor-in-chief, I attend countless off-the-record conversations with bankers who confess their experiences with financial technology companies. Sometimes, those experiences are anything but good, including a host of empty promises, botched integrations and disillusioned bank staff. It’s like the fintechs took off on the rocket ship but never made it to the moon, after all.

For one, banks and fintechs have a hard time speaking each other’s language. Banks, by nature and necessity, are focused on regulatory compliance. By contrast, technology companies tend to focus on growth, driven by nature and necessity to promise the world to their clients.

That seems to be changing. In the current economy and amid falling valuations for fintechs, many of them are focusing on profitability rather than growth for its own sake. And banks are changing, too. Small community banks, which we’ll define loosely as those below $10 billion in assets, historically have been reluctant to engage directly in partnerships with fintech companies unless those companies are offered by their core processors.

Traditionally, banks’ own policies forbid contracting with young firms that lack several years of audited financial statements, a fact that has excluded the vast majority of early-stage fintechs. But as fintechs mature in terms of compliance with banking regulations and as banks try to incorporate better technology into their systems, there is more room to meet in the middle.

This report is intended as a guide to help more banks take advantage of the offerings of financial technology companies to improve efficiency, customer relationships and to facilitate growth, and to do it in a way that mitigates risk.

First, though, I start with some terminology. Partnership gets batted around an awful lot. But what is it?

The Federal Reserve’s 2021 report, “Community Bank Access to Innovation Through Partnerships,” defines partnerships broadly to include traditional vendor relationships as well as more expansive arrangements that include shared objectives and outcomes, such as revenue sharing. We’ll adopt the Fed’s definition here, for ease of discussion.

In your journey to see what the universe may offer, Godspeed.

Why Digital Transformation Strategies Should Address Financial Wellness

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For banks, financially healthy customers are more profitable and more loyal, sticky customers. That means that effective financial wellness programs are not only the right thing to do for customers — they can also be a powerful tool for growth, even when net interest margins are under pressure.

Consumers who understand the basics of personal finance tend to be more engaged and profitable for the financial institutions they bank with, according to a study by Raddon Research Insights. A thoughtful strategy can make financial wellness programs an important resource for the communities they serve. As a former banker who is passionate about financial wellness and the impact it has on people’s entire life, I want to share my experiences and explain what other bank leaders should consider when strategizing their institutions’ financial wellness offerings.

Rethinking Financial Wellness
First, a financial wellness initiative that resonates for one bank’s customers may not be a good fit for another bank in a different market. Yes, community banks are uniquely positioned to support customers with financial education services and other financial wellness resources. But  a bank located in a college town that primarily serves university students should approach financial wellness and education differently than a bank in an area that’s popular with retirees.

Keep in mind the market and community your bank operates in, and your bank’s budget for its financial wellness program. This makes it much easier for your team to identify the opportunities that will make the greatest impact on customers, without being distracted by the latest digital innovations that may be interesting, but not relevant, to your institution’s needs.

Beyond that, how our industry thinks about financial education needs to change. There is no shortage of content in the market that tells consumers what to do to be financially healthy — but there are very few tools and products that actively help them take steps toward a healthier financial future.

People do not engage their bank with hopes of getting a new buy now, pay later solution, a mortgage or an auto loan. They engage their bank to help them buy a home for their growing family. Or they need to buy a car for the commute to their new job. Today’s customers want their bank to help them reach these important life milestones within their household budget and unique financial situation. Personalization should be a key aspect of any financial wellness program and services that banks roll out.

Personalized Guidance Is Key
A personalized approach gives banks a way to help customers make smarter financial decisions at their exact moment of need. Understanding consumers’ savings priorities and what they are actively saving for can help banks determine where they can make the biggest impact on their customers’ financial health.

Fortunately, Plinqit’s State of Savings Report indicates that an overwhelming majority of Americans — 91% — want to grow their savings and are putting aside at least some money this year. One of the top categories for saving this year was for paying off debt, which is notably different from saving money for the future or for a planned purchase. Yet, this is no surprise, given changes in the economy have led many Americans to rack up additional debt and the Federal Reserve’s interest rate hikes that have made it more expensive to borrow. The State of Savings Report reveals that nearly half of Americans, 42%, are putting money aside to pay down their debt. This is even greater of a focus for consumers between the ages of 18 and 34.

If this group is focused on paying down debt, banks should consider how they suggest personal loans and ways to refinance credit card debt. Credit card debt was the most cited type of debt that consumers are prioritizing paying down this year.

As consumers navigate the complexities of life events, unexpected expenses and economic challenges like inflation, saving money and achieving financial wellness can sometimes feel out of reach. Knowing how much money to put toward savings goals versus debt payments, when to start saving for retirement and other important financial decisions can overwhelm consumers. Banks must meet customers wherever they are in their financial journey to offer personalized financial guidance based on their goals.

Thoughtfully planning your bank’s financial wellness and education strategy will empower your institution to establish healthy financial habits among customers while supporting your bank’s future growth.

Driving Profits in Digital Banking

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In a rapidly evolving digital landscape, it can be tricky for financial institutions to figure out how to best generate profit from their digital initiatives. According to Stephen Bohanon, co-founder and chief strategy and product officer at Alkami Technology, a good starting point is also one of the most overlooked sources of revenue growth: existing customers. Bank leaders can also look at their competition to understand where to invest in technology.

  • Investing in the Front End
  • Evaluating Transaction Data
  • Expanding Wallet Share