How Innovative Banks Scale Consumer Loans

How Innovative Banks Scale Consumer Loans

January 08, 2020

By: Amer Buker, program director for FinXTech Connect

Read full article here.

Consumer loans can be an afterthought for most banks chasing bigger, commercial credits. Banks typically don’t market consumer loans, let alone originate them on a large scale, because these loans have historically been too small and inefficient to be profitable. But over the last ten years, fintechs have infiltrated this space in a big way. It’s time for banks to re-evaluate their offerings.

After the financial crisis, regulatory requirements for consumer loans became more cumbersome. Unsecured loans became an untenable product for some community banks; in their absence, fintech companies stepped in to fill the void. Fintechs originated 49% of all unsecured loans in the U.S. in 2019, up from just 22% in 2015, according to Experian.

They capitalized on high demand for consumer loans — now broadly called “personal loans” — with technological scale, enabling them to grab significant market share. Some fintechs are using technology to help banks to get in on the game too.

One such bank is First Federal Bank of Kansas City. The $819 million asset bank has focused on mortgages since its 1934 founding, but shifting home ownership trends in recent years prompted a closer look at the market. What executives found was that mounting credit card debt was a major barrier to home ownership. CEO J.R. Buckner decided to figure out a way to help customers over that hurdle.

One attractive option was a personal debt consolidation loan that would help customers get out of debt and begin saving, so that they could ultimately become mortgage customers. “[T]hink of the debt consolidation loan as an entryway into our philosophy on what it takes to experience financial wellbeing,” says Buckner.

The Kansas City, Missouri-based bank worked with Upstart to launch an unsecured personal loan product in the spring of 2019. Upstart’s technology uses about 1,600 data points to assess creditworthiness, an eye-popping number compared to traditional lenders, which typically use just 12 data points on average. That amount of data doesn’t work with simple regression analyses and spreadsheet calculations, so Upstart uses machine learning and automation to crunch the numbers.

Buckner confirms that Upstart’s model “is approving loans that we would have traditionally denied without the extra data points that they have,” so the bank can extend credit to more customers and, hopefully, put them on the path to savings and home ownership.

While First Federal is using personal loans to cultivate mortgage customers, Garden City, Missouri-based Lead Bank, is using them to bring new, underserved customers into the financial ecosystem.

A $357 million institution also in the Kansas City area market, Lead Bank already has a strong concentration in commercial real estate. So it was up to CEO Josh Rowland to find new “levers to pull” that would generate revenue in keeping with the bank’s mission.

One way is through its partnership with Self Financial. This Austin-based fintech found a unique way to package traditional financial products in the form of “Credit Builder” installment loans, which are backed by a certificate of deposit at Lead Bank and help people with thin-file or no credit history build up their scores without going into debt.

The partnership between Lead Bank and Self has been running for two years. Because the bank doesn’t advance borrowers money — the CD is funded once the customer has reached the required amount of equity — the program gives Lead a way to serve the underbanked without the risk of losses.

Lead Bank is also piloting a program of unsecured consumer loans with Helix. So far, the bank has seen “dramatic reductions” in the costs and losses associated with the Helix portfolios. Rowland says it’s too early to tell whether they’ve cracked the nut on what makes a profitable consumer loan program, but the bank has board support and is “not afraid to try.”

These partnerships aim to improve the financial lives of their respective bank’s customers. They help average people go from indebtedness to home ownership; from credit invisible to credit enabled. All warm, fuzzy benefits of financial inclusion and wellness aside, these new loans also present opportunities for both banks to acquire new customers and grow existing ones — but not without risks. Rowland estimates that unsecured consumer loan losses are around 30% for the industry; that’s a risk level a lot of banks won’t tolerate.

But Lead Bank is betting on its own hypothesis: The bank can use technology to reach a larger segment of borrowers, solving the scale problem inherent in consumer lending and providing the cover of the portfolio effect to ease potential losses.

Consumer loans are risky, and aren’t a fit for every bank. But they present a sizable opportunity for institutions looking for new revenue levers to pull, and all institutions must decide whether they’re in or out. Banks must take action to get back in the personal loan game, or risk forfeiting the space to fintechs.

 

 

About Lead Bank

For 90 years, Lead Bank has remained a strong, independent commercial bank dedicated to delivering smart financial solutions for business owners, managers and their families and communities. With locations in Garden City, Lee’s Summit and the Kansas City Crossroads, Lead Bank continues to provide treasury management, lending services, and personal client products. The flagship location in Kansas City’s dynamic KC Crossroads District introduces clients to a new “era of banking.”  A recipient of multiple local and national awards for innovation and culture, Lead Bank is the 2018 recipient of the prestigious “Mr. K Award”, named after the late Ewing M. Kauffman. This award goes to companies who has shown growth and sustainability of their business, a positive company culture and a record for giving back to the community. Lead Bank was also named in the Top 10 of United States banks as a “Best Place to Work” in 2019 by the American Bankers Association.  For additional information, call (816) 220.8600 or visit http://www.lead.bank/

 

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