Bank vs. Non-Bank Lending: Threats Facing These Institutions

Lending has evolved significantly over the last several decades. Financial institutions have come a long way since 1974, when banks controlled the lending industry, holding 62% of the total loans, compared to 2020, when non-banks issued 68% of all mortgages in the U.S.

The rise in non-bank lending has freed credit borrowers from the stranglehold of traditional banking institutions by providing them with an alternative lending market.

Non-Bank Lenders Vs. Banks

While the rise of non-bank lenders has revolutionized the lending market, non-bank lending has also inherited some risks synonymous with traditional lending services. Now, bank vs. non-bank lending faces threats and setbacks that may be interrelated or unique to each lender.

Before discussing the internal and external threats facing banks and alternative financial institutions, let’s first explore their history.

A Brief History of Bank vs. Non-Bank Lending

According to the World Bank, non-bank lenders are financial institutions without a full banking license and cannot accept public deposits. Non-bank lenders include venture capitalists, insurance companies, micro-loan firms, and currency exchanges. Non-bank lenders are a popular source of alternative consumer credit and command 14% of the syndicated loan market in the U.S.

Why and How Have Non-Bank Lenders Become a Thing?

The global financial crisis of 2007- 2008 significantly shaped non-bank lending as we know it today. Before the crisis, banks and traditional lending services had the most extensive loan holdings peaking at 62% in 1974. But as non-bank lenders became more prominent, banks’ loan share declined steadily and fell to 32% by the fourth quarter of 2009.

This saw alternative lending platforms grow significantly, especially within the mortgage market. At the same time, corporations embraced market-based financing and began issuing debt securities like commercial paper and bonds. Non-bank lenders snapped them up with more appetite than in the previous decades.

Since then, debt securities have been a more significant portion of the debt obligation of non-bank lenders. Corporations’ shift to mortgage securitization played a vital role in the rapid growth of alternative financial institutions, including organizations like Quicken Loans, Kabbage, OnDeck, and SoFi.

Advantages of Non-Bank Lenders to Borrowers

Non-bank financial institutions offer borrowers multiple benefits such as:

  • Less prohibitive criteria: customers with average or poor credit scores are more likely to access loans from non-bank lenders where traditional banks would turn them away.
  • Expedited loan application process and faster funding: non-bank lenders often approve loan applications swiftly and fund borrowers promptly.
  • Willingness to take higher risks: non-bank lenders don’t shy from higher-risk loans like traditional lenders. This makes them ideal for small business lending.

That said, let’s discuss the threats facing bank and non-bank lending.

Threats Facing Banks & Other Traditional Financial Institutions

Like most other sectors, the banking industry is witnessing a seismic shift that has compelled traditional lenders to rethink their business ways. This rapid transformation has brought about new internal and external threats, as discussed below.

Internal Threats

Evolving Business Models

In today’s world, traditional financial institutions are struggling to keep their primary sources of profits thanks to the rising cost of capital, a dip in proprietary trading, and a shrinking return on equity. Banks are rethinking their business model and implementing new and sustainable operational workflows to boost their profits while keeping customers’ trust and satisfying shareholders’ demands.

Customer Retention

Modern customers have higher expectations from their banks. To retain customers in this current age — where customer experience is king — banks must be more customer-oriented throughout every stage of their lending services. Or rather, focus on processes that enhance customer experience, such as dealing with the same point of contact during loan requests.

Regulatory Compliance

Since the 2008 financial crisis, regulatory compliance in the banking industry has increased significantly. Some significant regulations banks must comply with include Basel III, the Dodd-Frank Act, Current Expected Credit Loss (CECL), and the Allowance for Loan and Lease Losses (ALLL). Complying with these regulations takes more time and resources from the banks. These complex compliance rules are pressuring traditional financial institutions to act with greater responsibility and honesty in their lending practices.

External Threats

Increasing Competition

The entry of FinTech companies such as Kabbage, Lending Club, and Personal Capital has taken a good share of customers away from the banks. To contain FinTechs and retain their revenue, top banks are investing in FinTechs through partnerships or acquisitions to influence or control alternative lending industry trends.

Security Breaches and Poor Security Practices

Cybersecurity is one of the most substantial risks facing financial institutions today. Banks must invest in the best encryption technologies to fortify their security and prevent data breaches and loss of money through cybercrime.

Increasing Market Expectations

Today’s customers want real-time round-the-clock service and are loyal to banks that act more like their financial partners. Banks must meet high customer expectations to keep and attract modern customers.

Rapidly Advancing Digital Technologies and Innovations

Banks must integrate new technologies such as blockchain, application programming interfaces (APIs), artificial intelligence (AI), and cloud computing into their work processes to stay in business.

Threats Facing Non-Banks & Other Alternative Lending Companies

Internal Threats

Non-banks’ business model is their biggest self-risk. Because they hold more relaxed eligibility criteria, they may issue high-risk loans to borrowers with less-than-perfect credit scores, and the risk of default in an economic downturn is high.

Also, there’s mounting pressure and concern from federal regulators that non-banks are under-regulated. There’s a risk that non-bank regulatory compliance may be updated, forcing non-banks to operate under the same rigid regulations traditional banking faces.

External Threats

Non-bank lenders, similar to traditional banks, face heightened cybersecurity risks. The rapid expansion of financial tech is another threat to non-banks. Although most non-banks utilize the latest innovations, the fast evolution of tech keeps them on the verge of falling behind competitors. Subsequently, they must constantly innovate to retain their market edge.

Lastly, competition from traditional banks is a growing threat to non-banks. Major U.S. banks like Goldman Sachs are entering the FinTech field with huge investments. Traditional lenders are streamlining their business models to offer equal or better customer service. This way, banks attract more customers who previously preferred non-bank lenders.

How Credit Risk Management Software Can Help

Whether you’re a traditional or non-bank lender, you need to make sense of banking analytics in your credit risk management process. This involves analyzing varied customer data to enhance your pre-qualification process, providing a turn-key digital origination platform, and reinforcing your collection process.

GDS Link leverages AI-driven decision-making to help you make sound conclusions in all your lending processes. GDS Link provides crucial banking insights and advisory services to drive growth within today’s changing lending landscape.

Request a demo today, and see how GDS Link can elevate your financial institution.

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