Lenders are preparing for a difficult year ahead as pandemic tailwinds cease at the same as high inflation and a host of related economic headwinds start to gather. But some also see opportunity.
While most agree they don’t want a re-run of the worst of 1970s - winter power cuts, strikes, spiralling inflation, bankruptcies, unemployment and sluggish growth - much of it already seems to be happening or expected to in the coming months.
For nimble digital lenders, particularly those poised to react quickly to new data sources, this could, however, be another period of accelerated growth following on from gains made during the pandemic.
Lending could soon become amuch more polarised market with low-risk businesses and low-risk consumers still having plentiful access to credit but higher risk borrowers cut out.
The former will therefore be courted more heavily by a larger group of lenders. The latter, the opposite. Lenders meanwhile will require a suite of new data sources to price both groups accurately. Fintech-enabled firms may well be best suited to these conditions.
In normal times lenders are able to forecast their lending over a number of years based on the probability of a variety of outcomes. But now, that time horizon has shrunk.
“Now, things change quite rapidly. And this poses challenges for lenders. But at the same time, I think it also brings elevated chances, to not just take, the easy route of saying I'm going to stop lending to consumers just to play it safe,” Arie Wilder, chief operating officer of Auxmoney, one of the largest digital consumer lenders in Europe, told AltFi on a webinar last week,
“At the same time if you are fast, if you have a testing mentality and if you're very analytical, and also embrace the power of additional data... then it's also still a time to win market share and support those consumers in a responsible way with capital and at the same time, do good business,” said Wilder.
While this scenario makes risks harder to calculate and therefore potentially more catastrophic, prompting some lenders to pull back from the market until the storm clouds disperse, Wilder says fintech lenders may have the advantage to take new market share from incumbents.
“It's just more uncertain. You have to think more in scenarios. You have to be fast and very analytical. And then I think it's a time that can be manoeuvred through successfully,” he said.
Chris Keane at GDS Link, which provides credit risk tools to lenders, says many borrowers - both businesses and consumers are seeing the end of the pandemic’s distorting effect on their financial profiles.
“There's a whole cohort of consumers who are really feeling the pinch through the rising cost of living and businesses that have had their balance sheets flattered through Covid support schemes,” said Keane.
Katrin Herrling, Funding Xchange’s CEO, says we're starting to see failure rates for a cohort of SMEs going up after the ‘normal’ signs that you would see to understand risk profiles of businesses become less muted.
This impact is ending, with the government cash and the effectiveness of protection that it is extended to the business sector coming to an end.
“We're seeing - if you look at just the last two years as a lender - you might well be left with the impression of operating in a very, very benign environment is the very low defaults. And even very low delinquency rates,” said Herrling.
“These risks signals are incredibly misleading... we can see this in very early warning signals already, that we're returning to a much more conventional impact of risk on the behaviour of businesses,” said Herrling.
The removal of support from Government-backed Covid loan schemes’ to businesses and the unwinding of consumer savings buffers stockpiled during the pandemic means we are in a new era for lending.
The next twelve months as a result will become harder for lenders to assess SME borrowers, says Herrling.
“What we're seeing is that we're coming out of a period of huge upheaval that did not pan out like a normal recession because of the government interventions that were highly effective. We've seen two years in which portfolios for lenders have actually performed incredibly well,” said Herrling.
“This is the effect of £87bn or so in funding being made available to UK businesses through loan schemes, and then additional support through other schemes that the government has in place as well” she added.
Wilder says the same can be applied for consumers.
“We see that the economic recovery after the corona pandemic is now slowing down and there are severe economic consequences for consumers. Mostly inflation and rising energy costs which certainly put pressure on affordability of customers,” said Wilder.
However, he adds that the overall labour market points to a more robust environment in Germany, offering some hope.
“If you think about the consumer lending sector in Germany, though the situation causes much more uncertainty than when you compare to five years ago,” said Wilder.
A key question for lenders is whether to pull back from lending in such uncertain times. Lenders need to know which customers are ‘good’ risks and which customers are now most vulnerable when a complete pullback is not an option.
Wilder says Auxmoney is “not t pulling back completely.” But is taking measures to lend more responsibly as well as protect the investors' returns by making sure that default rates are not increasing too steeply.
“So we definitely have looked very carefully into the individual segments and also became more restrictive in certain segments in which we don't believe it's a good idea to grant additional credit at this moment,” said Wilder.
Many lenders are in a similar boat, not wanting to pull back from lending after two and half years of the pandemic.
“We have seen that the decimated portfolios of some of the larger digital lenders have to be rebuilt…by those who have not been able to use the government schemes to maintain the size of their portfolios,” Herrling said.
This is because the size of a lender’s overall portfolio of loans drives its income. A complete pullback means going out of business.
“There's an economic reality, that having to deploy funding is also part of surviving as a lender. I think the way this is playing out is that everyone's trying to find good businesses to lend to and trying to find lending models that protect them,” said Herrling.
However, she says it's become much harder to access wholesale funding and this is restricting the supply of funding in the market. Owing to a number of factors this target segment of ‘safer’ business lending is becoming smaller.
For households, borrowing is going up. UK consumers doubled their borrowing - mostly via credit cards - in June compared to May, up from £900m to £1.8bn, according to the Bank of England. Second mortgages seem to be back in vogue too, with a 43 per cent year-on-year increase in May, according to industry data, as households look to debt to meet their inflated needs.
For lenders, a long looked-forward to higher interest rate environment comes at a time where demand is sky high for their loans but this is being marred by one of the toughest economic outlooks for half a century.
Whichever you play it there are amplified. business risks. Pulling back from lending means losing income. Lending responsiby also means losses. Some, however, also believe it can be a huge opportunity for fintech lenders can calcify a stronger market position over the medium term despite it being their first experience of an economic downturn.
24 March 2023
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