Lending has evolved significantly over the last several decades. Financial institutions have come a long way from 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 played a significant role in shaping non-bank lending as we know it today. Before the crisis, banks and traditional lending services had the largest 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 larger portion of the debt obligation of non-bank lenders. This shift to mortgage securitization by corporations played a forefront 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 as traditional lenders do. 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 old ways of doing business. This rapid transformation has brought about new internal and external threats, as we discuss below.
Internal Threats
Evolving Business Models
In today’s world, traditional financial institutions are struggling to keep their main sources of profits thanks to the rising cost of capital, dip in proprietary trading, and a shrinking return on equity. Banks are rethinking their entire business model and implementing new and sustainable operational workflows that can 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 of the major regulations that banks have to 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 not lose much of their revenue, top banks are investing in FinTechs through partnerships or acquisitions in an attempt to influence or control alternative lending industry trends.
Security Breaches and Poor Security Practices
Cybersecurity is one of the most consequential 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 the banks that act more like their financial partners. Banks must level up to 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 a more relaxed eligibility criteria, they may issue high-risk loans to borrowers with less than perfect credit scores, 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 in the future, 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 for non-banks. Major U.S. banks like Goldman Sachs are entering the FinTech field with huge investments. Traditional lenders are also streamlining their business models to offer equal or better customer service. This way, banks are attracting more customers who would previously prefer 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 you with the crucial banking insights and advisory services you need 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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