The evolution of lending towards a digital ecosystem, in 4 charts

Lending is experiencing a digital shift, driven by evolving technology, alternative and real-time data sources, as well as a changing customer-centric financial landscape. 

The evolution of lending comes in the context of a banking and financial services industry that has changed significantly over the past decade – new technologies have lowered barriers to entry, and computing and storing power have grown exponentially, which gave financial institutions the ability to collect, structure, and analyze data in real time.

“API technology, the platform economy, embedded finance and open banking have created fertile ground for innovation in lending. We are seeing the transformation of lending, where every stage of the borrower process is data-driven, real-time and personalized,” said Ian Johnson, SVP and managing director at Marqeta.

In a new report, Marqeta outlined a timeline of how the lending industry has evolved, and defined a third stage in lending:

Lending 1.0 - Borrowing money was paper-based and slow, repayments were fixed, and lenders had poor visibility of how loans were spent. 

Lending 2.0 - After the 2008 financial crisis, credit providers used digital technology and real-time data to offer online applications.

Lending 3.0 - Accelerated digital transformation and alternative data sources allowed lenders to digitize analogue processes at every stage of the customer journey, resulting in better lending solutions for both consumers and businesses.

Fintechs are innovating the lending process by streamlining identity verification without compromising onboarding, assessing risks through new data sources. Others are making credit more accessible to underserved parts of the population, using new underwriting and risk assessment techniques.

This new age of digital lending is all about personalized, intuitive loans which offer lenders better approval rates, fewer defaults, and lower distribution costs, the study found. Drilling down into different stages of the lending process, Marqeta outlined the changes brought about by this new digital lending ecosystem. 

Identity checks 

Verifying a customer’s identity is no longer a time-consuming process involving physical documents. Lenders can now use digital attributes such as facial recognition and biometrics to approve borrowers within minutes, cutting KYC and compliance costs and streamlining back-office processes. 

“The main thing about digital is the ability to do things quickly and at scale. If we were trying to underwrite analogue style, we’d have to input the numbers somewhere and make a decision based on human eyes looking at it,” said Alex Miles, UK managing director of Capital on Tap.

Source: Marqeta

Credit assessments

Transaction data analysis allows credit scores and background checks to be more accurate and personalized. Lenders can use this information to personalize rates, terms and payments to help borrowers manage cash flow volatility. 

“If you can understand where people have been transacting for the last 24 months, you can build a strong profile of who that person is and what they need from you. And you can tailor an offer to them which is much more personalized and therefore will feel much more intuitive,” said Tim Davis, CEO at Butter, a UK-based BNPL provider.  

Source: Marqeta

Disbursements

Customers previously had to wait days for their credit card to show up in the mailbox, but now card issuance happens instantly in mobile wallets. This means real-time access to capital for borrowers, a convenience that helps build long-term loyalty. It also removes some of the psychological barriers to borrowing, as borrowers don’t have to undergo lengthy application processes.

“In the modern banking world, the credit application is seamlessly integrated at the point of sale. All information needed to underwrite a company is pulled through several databases automatically upon approval of the applicant, via Open Banking with PSD2. And lending decisions are taken instantly,” said Christian Grobe, co-founder and managing director at Billie, a BNPL provider for businesses. 

Source: Marqeta

Repayments

Repayments can now reflect a borrower’s particular circumstances, helping to bring down delinquency rates. Lenders can adjust and enhance credit risk modeling and build comprehensive customer profiles using real-time transaction behavior. With digital tools like dynamic spending controls, borrowers can budget and monitor their finances easier.  

“In the UK, the insights to financial behavior provided by open banking have been a key data source for Lending 3.0. The benefits to lenders of adopting the technology are well understood and are measured in the pounds and pence of increased acceptances and reduced defaults,” said Credit Kudos head of product, Angus Clacher. 

Source: Marqeta

The challenges of Lending 3.0

While presenting exciting new changes in the traditional lending system, Marqeta found that this new era of digital lending comes with a few challenges as well. 

Data: Despite the ever-growing pool of data, this resource remains fragmented, owned by different suppliers. This makes it difficult in practice for financial services providers to use more than a tiny fraction. 

“Significant collaboration with third-party data providers, such as utility companies, social media providers, mobile network operators and other specialized data vendors, is required,” Marqeta said in the report. 

Regulation: The legal environment contributes to the complexity of digital lending, as the increased use of data generates concerns about privacy and data ownership. 

Regulators are also increasingly looking to intervene in new markets like BNPL, fearing that it’s becoming too easy for consumers to grow their debt burden without benefiting from protections like with traditional credit products. 

Technology: The rapid digital transformation in financial services is leaving some legacy players behind, pressuring them to overhaul their internal systems to be able to keep up.

“Long-standing providers may be at a disadvantage due to the rigidness and complexity of legacy systems. And if they’re limited in their ability or willingness to adopt the latest technologies, before long, this will result in a decline of competitive advantage and customers,” Justus Roux, solutions engineering manager at Mambu, told Marqeta.