Installment loans: When business no longer runs on its own ...
Installment loan business has always been a key earnings driver in the American banking market - and has shown high growth rates in recent years in particular. The CAGR in new loan issuance, for example, was around 7% between 2014 and 2018. And at least as impressive: the increases were accompanied by an average effective interest rate of around 5-6%.
The big question now is: Can these figures be maintained despite COVID-19? In terms of new lending, our guess is "yes" - for two reasons:
Demand will be stimulated by a government-imposed stimulus program
The situation is somewhat different, however, when it comes to profitability. Here there are increasing signs that the industry will come under pressure. This is shown by a recent survey we conducted among major American banks.
Specifically, as a result of the worsening economic crisis, risk costs in the installment loan business will rise significantly. At the same time, COVID-19 is likely to exacerbate another trend that is weighing on profitability - namely, that customers are using digital channels more and more intensively and comparing different providers. This will weaken ties to banks, which will open up the market to new players.
Already today, according to the survey participants, on average more than 40% of new customers come via the bank's own online channels, almost one-fifth via comparison portals and only one-third via branches. It is therefore becoming increasingly important to make the application process more efficient and customer-friendly, while at the same time making the credit decision more informed - and optimally aligning pricing. This means focusing on the real risk of default. But also the customer value.
So what are the individual levers? How far have American banks come in terms of "application process," "credit decision," and "pricing"? Where do they need to catch up, and where is there potential? Here are the core results of our survey:
1.) Application process
The period between application and loan disbursement still takes 2-3 (working) days on average.
A high proportion of loan applications are abandoned; around 70% of customer abandonments take place during the application process. Reasons for this: long processing times, subsequent delivery of documents (e.g. proof of income), and too great a difference between the shop window price and the final price
We expect a steady shift to immediate payment in the coming years. However, this requires that other key cornerstones of the processes (e.g., loan decision, pricing, etc.) be fundamentally optimized
2.) Credit decision
The use of transaction data (keyword PSD2) is already being used by half of the participants for internal accounts, and by a third of the participants for external accounts, in order to improve the credit decision accordingly (e.g., filling the credit application with information already available, validation of customer details)
In our view, further data such as geo-localization or profiling (e.g., collection by fintechs) have a positive added value on the quality and efficiency of the credit decision. However, very few banks in English-speaking countries are currently planning to introduce them. There is still a lot of potential here: over a third of all banks in other European countries have already effectively integrated these data sources into their credit decision processes
All those that still make little or no use of these "innovative" data sources to make lending decisions will face significant night-time disadvantages in the long term.
3.) Pricing and customer value management
Only one-third of survey respondents use price elasticity and less than one-fifth use customer value methodologies as elements of pricing
Similarly, product specifics such as different prices per loan amount or loan term are used by only one-third of banks
Compared with European banks, local market participants can still optimize pricing considerably by determining the actual customer value and incorporating it into pricing
Banks must also become more flexible with regard to alternative credit offers. To date, only the loan amount or term has been adjusted if the initial application is rejected due to the customer's financial situation.
The introduction of risk-adjusted pricing and the use of additional products as possible alternative offers are key levers for maximizing customer value.