Making Consumer Lending Profitable for Your Bank

lending-2-12-18.pngThe economy has recovered significantly since the financial crisis in 2008. The stock market continues to thrive. The unemployment rate is the lowest it’s been in almost two decades, and there’s more demand for housing than ever before. Consumer lending has substantially increased in the past year, and now that the U.S. has returned to more prosperous times, it only makes sense for community banks to open their doors again to welcome consumer lending—and make a sizeable profit while they are at it.

The Great Recession brought a more restrictive regulatory environment and calls from legislators for revision and change in the banking industry. Facing heightened regulatory concerns, many community bankers abandoned potential revenue from consumer lending in the face of mounting costs. For example, total costs for originating a $30,000 unsecured consumer loan in a bank branch could be over $3,000, making the overhead and costs unattractive to many bankers. With an improving economy and a need for higher yielding assets, community banks are looking for ways to lower these costs and make consumer lending profitable again.

The consumer lending landscape has changed drastically in the past decade. The space has gone through a digital transformation led by marketplace lenders focused on disrupting traditional brick and mortar banks. These marketplace lenders are not yet as highly regulated as banks, enabling their online lending platforms to thrive in the current economy with little to no legislation working against them.

Many community banks lack the internal expertise, infrastructure and resources to quickly build their own digital lending platforms. Those that do build their own platforms face the challenge of keeping the platform current and fully compliant while still delivering an exceptional experience that meets the needs of today’s digital banking customer. This creates significant costs in capital expenditures for the platform’s infrastructure, and lofty operating expenses for the institution to continue to competitively offer these products and maintain regulatory compliance.

Banks can dramatically decrease both the cost and time-to-market for a digital lending platform by partnering with technology providers. Implementing and launching a digital lending platform can take as little as six weeks by partnering with an outside provider, and these partnerships provide the necessary infrastructure banks are looking for without having to build and staff internally. In contrast to the high costs of originating loans in a traditional branch, the digital platforms provided through technology partnerships can lower total costs to originate that same $30,000 unsecured consumer loan down to roughly $750, making it significantly more profitable for the bank. The reduced costs and reduced risks in creating these platforms is resulting in an increase in technology partnerships.

Choosing a digital lending platform provider that understands the regulatory and compliance complexities facing the banking industry, and focuses on a higher standard of customer service, should be a top priority for community bankers in 2018. The boards and management teams of these institutions should seek partnerships with endorsed technology providers that demonstrate a keen eye for ever-evolving regulations, exceptional customer experiences and lucrative lending opportunities for the future.

How Community Banks Can Grow Loans by Partnering With Competitors

bank-capital-8-5-15.pngWhat many bankers have seen as the industry’s greatest peril is suddenly becoming their most powerful possibility: shadow banking. Shadow banking is frequently the term used to describe nonbanks who offer services and products that are similar to what banks offer. A new business model for community banks is transforming shadow banks from rivals to partners, enabling the two worlds to partner to compete with the biggest banks in ways community banks standing alone never could.

How could shadow banks that often compete directly with banks instead enable something entirely different? Imagine a world in which community banks—currently limited by their smaller scale in the array of products and services they can deliver to their customers—combine their acclaimed community focus, service and customer experience with the reach, depth, technology and convenience of direct nonbank lenders.

That sounds, but isn’t, almost too good to be true. The explanation lies in both what community banks already know—what separates them from the largest banks—and in what they may not: the ways in which shadow banking has evolved, offering products that can complement and empower rather than compete and threaten.

The biggest institutional banks—the five to 10 largest—are often inefficient, stodgy and misaligned. They resist innovation. Their legacy burdens include bad systems, faceless and painful customer experiences, and regulatory issues. Yet they have the capital and reach to provide consumer loans, often at interest rates that can top 20 percent (think credit cards) in a less competitive environment because community banks lack the scale to go up against them.

The more than 5,000 community banks in the country are innovative, agile and acclaimed for customer service. By definition, they can never be too big to fail. Together, they hold $2.3 trillion in assets—14 percent of the economy.

Yet as many types of lending have shifted from relationships to technology, community banks have lacked, first, the expertise, resources and scale to offer these services themselves, and, second, the technology to connect their own platforms with those that can. It’s little surprise that their share of the consumer lending market has collapsed from more than 80 percent to less than 10 in the last 25 years.

Recently, new nonbank lenders like Lending Club have exploited the inefficiency of the big banks by providing direct loans with best-in-class customer experiences. They offer better returns to investors and better rates to customers. But these new nonbank lenders have come to recognize they lack existing relationships with customers and low-cost, stable capital—exactly what community banks have in abundance.

A new model holds out the promise of combining the ideals of community banking—trust, service, relationships, low cost capital—with the best of these new nonbank lenders: scale, efficiency, technology and superior customer experience. The idea is to bind community banks together into alliances with nonbank lenders. This blends the service of the former with the lending platforms of the latter and allows each to do what it is uniquely good at—all while providing the customer with the best possible product and experience. The only losers: the biggest banks.

My organization, for example—BancAlliance—has gathered more than 200 bank members across 41 states into a collaborative pool with the scale and expertise to compete with the largest banks. We’ve assembled an innovative partnership between this group and Lending Club to offer community banks a consumer lending platform so they no longer have to turn away customers looking for consumer loans—and so they can focus on what they do and know best, which is serving individuals face-to-face. The first bank went live with offering loans through this partnership via its website just this summer.

Surely other models will emerge, and there will be enormous opportunities to replicate this approach to other products, such as unsecured small-business loans, that make sense (but are challenging) for community banks. Some trends are clear. One is that the big banks no longer own an exclusive title to this space. Another is that community banking remains as competitive—and crucial—as ever. Finally, and every bit as important, shadow banking is no longer solely competition for community banks. For community banks, the opportunities it presents are suddenly compelling and potentially transformative.

Opening the Consumer Lending Market for Community Banks

As recently as 1990, community banks had a 79 percent market share in consumer lending. Today, that share has dropped to just 8 percent as the biggest banks have capitalized on economies of scale to displace community banks. As a result, many community banks no longer have viable independent consumer lending businesses. Brian Graham, chief executive officer of Alliance Partners, an SEC-registered investment adviser that provides administrative services to BancAlliance and advisory services to BancAlliance members, explains how BancAlliance has partnered with Lending Club to offer community banks the chance to participate in this $3.2 trillion market.

Why did BancAlliance get into consumer lending?
BancAlliance exists to serve the goals of our member community banks, and those members have been asking us to explore approaches that would let them compete with the biggest banks for consumer loans. Based on extensive diligence and audits of potential partners, we have joined with Lending Club due to the scale and quality of its consumer finance business. 

How can community banks compete with large national banks in consumer lending?
BancAlliance allows community banks to collaborate, pooling their individual capabilities. Collectively, we are taking advantage of Lending Club’s highly efficient and advanced servicing and origination functions in order to provide our member banks a “plug and play” consumer finance platform. BancAlliance members can mimic the economies of scale that larger national banks experience by utilizing the tools Lending Club has had in place for years. Recent OCC guidance has encouraged community banks to “achieve economies of scale and other potential benefits of collaboration” in a January 2015 paper, and BancAlliance offers banks an opportunity to join together with a premier name in consumer lending.

Why Lending Club?
Lending Club is the market leader among lenders in unsecured consumer installment credit. Lending Club, which recently went public, is very focused on regulatory compliance matters, given that it works with several bank partners in addition to BancAlliance. Lending Club has well-defined policies and procedures that BancAlliance has validated through several outside reviews. BancAlliance believes Lending Club is a strong partner and is well-positioned to work with us and our members to help them return to their consumer lending roots. Additionally, Lending Club has stated that forming partnerships with community banks is a critical strategic activity, and is focused on fully developing the BancAlliance relationship.

What does this partnership entail?
BancAlliance partnered with Lending Club to allow community banks to offer their customers very competitive consumer loans, as well as to provide an opportunity for BancAlliance members to purchase bank-quality consumer loans from Lending Club’s platform. The joint nature of this relationship allows both parties to benefit from the other’s strengths.

What benefits does this partnership bring to bank customers?
For most bank customers, the interest rate on the consumer loan is well below that on credit cards or other debt. Lending Club provides consumers with a simple, fixed-rate product without teaser rates that can cause a consumer’s debt service to increase unexpectedly. On average, consumers borrowing on the Lending Club platform experience savings equivalent to 32 percent when compared to high-rate credit cards. In addition, since these loans are fully amortizing, the program puts customers on a path to reduce debt and improve their financial outlook and credit. According to Lending Club historical data, customers that take out a loan see an average FICO score increase of 23 points within three months of obtaining a Lending Club loan.

What benefits does this partnership bring to BancAlliance?
First, BancAlliance member banks benefit from the broader and deeper relationship with their customers and a larger share of wallet. Banks no longer have to tell their customers they cannot offer them this product. Second, banks enjoy higher levels of loans with attractive yields, as well as incremental fee income from referred loans. Banks enjoy risk benefits as well, diversifying their portfolios by loan type and geography. Most important, BancAlliance banks receive all of these benefits without having to make any material upfront investment and with minimal ongoing operational costs. Consumer lending is most efficient when done on a large scale basis, and this program allows community banks to mimic this scale without incurring the costs necessary to create it on their own.