How to Optimize Credit Risk and Increase Lending …solutions.yodlee.com/rs/789-EJH-884/images/EB_How-to...How to Optimize Credit Risk and Increase Lending Profitability 7 As banks

How to Optimize Credit Risk and Increase Lending Profitability

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How to Optimize Credit Risk and Increase Lending ProfitabilityIt’s No Secret Financial Institutions are Seeking Alternative Measures To Stay Ahead of the Curve.

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Table of Contents

Introduction 3

Emerging from the Financial Crisis 4

Dealing with the Gap 6

Growing Fast 8

The Numbers Game 10

Increasing the Customer Pool 12

The Advantage of New Data 14

Time Is Money 16

Partnering to Gain Competitive Advantages 18

Small-Business Owners Are Traditional 20

Envestnet | Yodlee Risk Insight 22

Conclusion 23

© 2016 Envestnet | Yodlee.™ All rights reserved. Technology protected by one or more U.S. Patents or Patents Pending. Use subject to license terms. May include materials developed by third parties. Yodlee and the Yodlee Logo are trademarks or registered trademarks of Envestnet | Yodlee in the U.S. and other countries. All other trademarks mentioned in this document or website are the property of their respective owners.


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Introduction

Financial institutions are seeking alternatives in lending due to the significant changes happening within the lending industry. There is pressure from non-regulated competitors growing in all segments, from payments to wealth management to lending that is making financial institutions re-evaluate their options. In pursuit of these new approaches, financial institutions can now leverage new technologies and data sources. In doing so, they can create more thorough financial picture of consumers and small business, which can give them the ability to provide more profitable loans within acceptable risk tolerances.


Emerging from the Financial Crisis


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Following trends that started before the financial crisis struck in the mid-2000s, the volume of small business loans continues to fall despite incentives designed to spur lending. The share of small business loans accounted for 50 percent of all loans in 1995. That figure fell to 30 percent in 2012. Meanwhile, loans to larger businesses increased 4 percent during that same span.1

“Bank credit for small businesses showed ‘a steady decline prior the crisis, was hit hard during the crisis, and has continued to decline in the recovery as banks focus on more profitable market segments.’”1

1 Mills, Karen Gordon, and Brayden McCarthy. “The State of Small Business Lending: Credit Access during the Recovery and How Technology May Change the Game.” Harvard Business School, July 22, 2014. http://www.hbs.edu/faculty/Publication Files/15-004_09b1bf8b-eb2a-4e63-9c4e-0374f770856f.pdf.


Dealing with the Gap

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As banks looked for better profits in larger loans, a new type of digital technology firm began to fill the hole in the market for smaller loan seekers.

With an emphasis on making financial services more cost efficient for lenders and less confusing for borrowers, alternative lenders are finding good risks in thin credit reports by supplementing them with additional data from non-traditional sources including: current cash flow, bill payment history, and forecasting.

“39.8 percent of people with credit histories shorter than three years have credit scores higher than the subprime threshold, generally good enough to obtain a loan.”2

2 “Peer-to-Peer Lending Is Poised to Grow.” Clevelandfed. Accessed March 02, 2016. https://www.clevelandfed.org/newsroom-and-events/publications/economic-trends/2014-economic-trends/et-20140814-peer-to-peer-lending-is-poised-to-grow.aspx.


Growing Fast


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The alternative lending industry is still emerging, but it’s growing fast. While the number of consumer finance loans decreased 2 percent since 2007, consumer loans through alternative lenders grew at an average of 84 percent per quarter during that time.3

Alternate lending fills as least two gaps: it can improve credit access to people with gaps in their credit files, and it can help consumers consolidate credit-card debt at lower interest rates.

“Interest rates on peer-to-peer loans have been lower than those on credit cards since 2010:Q1.”3

3 “Peer-to-Peer Lending Is Poised to Grow.” Clevelandfed. August 14, 2014. https://www.clevelandfed.org/newsroom-and-events/publications/economic-trends/2014-economic-trends/et-20140814-peer-to-peer-lending-is-poised-to-grow.aspx.


The Numbers Game

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Loan origination volume estimates vary, but the constant theme is that alternative lending volumes are showing triple-digit growth in both the United States and the United Kingdom. Prime Meridian Capital Management estimated industry loan origination could reach $18 billion in 2015.

“Peer-to-peer lenders in the US generated $6.6 billion in loans in 2014, up 128 percent.”4

4 Bakker, Evan. “PEER-TO-PEER LENDING MARKETS: The Leading Countries for Alternative Finance and the next High-growth Markets.” Business Insider. June 17, 2015. http://www.businessinsider.com/peer-to-peer-lending-markets-the-leading-countries-for-alternative-finance-and-the-next-high-growth-markets-2015-5.


Increasing the Customer Pool


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A 2015 FICO study revealed approximately 25 million U.S. consumers — or about 10 percent of the adult population — were “credit invisible,” meaning they did not have credit history with a national credit bureau. Another 28 million consumers didn’t have enough credit to be scored.

Given the weight placed on national credit bureau scores, it’s unlikely those consumers or business owners would receive loans from a traditional financial institution. Many of them, however, have the cash and earnings to repay loans without difficulty.

“Augmenting traditional credit scores with alternate data makes it possible to generate predictive credit scores for more than 50 percent of previously unscorable credit applicants and to help provide unbanked consumers a safe onramp to mainstream credit.”5

5 “Can Alternative Data Expand Credit Access?” Fico.com. October 8, 2015. http://www.fico.com/en/blogs/risk-compliance/can-alternative-data-expand-credit-access/.


The Advantage of New Data


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The consumer and small business lending space will continue to be a key battleground for financial service providers. Alternative lenders gained the upper hand using new tools and data sources to better grasp the risks associated with lending to consumers and small business while improving the application process.

The technologies developed by the alternative lenders boost consumer confidence and transparency. It might take weeks for a traditional lender to reach a decision on a loan, but the platforms developed my alternative lenders tend to return results within days, hours, or even minutes.

“Borrowers benefit from a streamlined application process, quick funding decisions, and 24/7 access to the status of their loans.”6

6 “Peer Pressure: How Peer-to-peer Lending Platforms Are Transforming the Consumer Lending Industry.” Pwc.com/consumerfinance. February 2015. https://www.pwc.com/us/en/consumer-finance/publications/assets/peer-to-peer-lending.pdf.


Time Is Money


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While traditional banks may offer low rates, the application process is time-consuming. The Federal Reserve Bank of New York reported business owners spend an average of 24 hours applying for credit. That’s an enormous amount of time that most business owners could better use running their company.

The fact that businesses struggle to get approved only compounds matters, and if they are approved, they’re often required to put up major assets — such as their home — as collateral.

“Among applicants, there is a strong demand for small loans of $100,000 or less, with many firms borrowing to expand.”7

7 “Joint Small Business Credit Survey, 2014 - FEDERAL RESERVE BANK of NEW YORK.” Joint Small Business Credit Survey, 2014 - FEDERAL RESERVE BANK of NEW YORK. February 17, 2015. https://www.newyorkfed.org/smallbusiness/joint-small-business-credit-survey-2014.html.


Partnering to Gain Competitive Advantages


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These new technologies aren’t just for alternative lenders. They can also be utilized by traditional financial institutions.

By using the same risk-management tools and loan-origination process, traditional banks can expand into new markets and enhance productivity. By combining new technologies with “smart” application tools that tailor the loan interview to the applicant’s circumstances, traditional financial institutions can improve efficiency and make the applicant’s experience more positive.

8 Ginovsky, John. “Community Banks, Alternative Lenders, Can Coexist.” Www.bankingexchange.com. October 16, 2015. http://www.bankingexchange.com/community-banking/c-suite/item/5810-community-banks-alternative-lenders-can-coexist.

“The traditional strength of community banks — intimate knowledge of their communities and local businesses — could be meshed with the faster decision making and funds provision that alternative online lenders employ.”8

Lael Brainard, Federal Reserve governor


Small-Business Owners Are Traditional

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Small business owners would be receptive. They rely on trusted financial partners when making fiscal decisions. That trusted partner tends to be a traditional banker, according to Harvard’s “State of Small Business Lending” paper.9

“48 percent of business owners use a major bank as their primary financing relationship… 34 percent use a regional or community bank.”9

9 Mills, Karen Gordon, and Brayden McCarthy. “The State of Small Business Lending: Credit Access during the Recovery and How Technology May Change the Game.” Harvard Business School, July 22, 2014. http://www.hbs.edu/faculty/Publication Files/15-004_09b1bf8b-eb2a-4e63-9c4e-0374f770856f.pdf.


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Envestnet | Yodlee Risk Insight Financial institutions need an upper hand with technology and data to maintain a competitive edge in lending, especially when granting lower-dollar loans to small businesses and consumers.

Envestnet® | Yodlee® Risk Insight is a packaged solution that captures data elements not available through the credit bureaus. This includes income data, cash flow data, bill payment history, account receivables, account payables, payroll, and outside investments.

This powerful big data solution enables financial institutions to glean critical business income and spending insights, providing those institutions with better data to asses a borrower’s credit risk. This can boost profitability while reducing the chance of loan risks and defaults.

Envestnet | Yodlee’s Financial Data Platform connects financial data from over 15,000 global sources. More than 71 percent of this data comes from direct data feeds with leading financial institutions, which enables speed and performance and reflects the strength of Envestnet | Yodlee’s connection and banking relationships.


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Conclusion

The tools created by alternative lenders can help financial institutions better distinguish good risks from bad ones. Having accurate, integrated, and transparent data with a holistic view of the consumers financial standing can drive confident, proactive decisions and help financial institutions rebuild profitable small business loan portfolios while fulfilling regulatory risk limits and customer preferences.

How can I learn more?

• Download the whitepaper: “Optimizing Credit Risk for Increased Lending Profitability”

• Download the data sheet: “Envestnet | Yodlee Risk Insight”

For more information, visit: www.yodlee.com.

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© 2017 Envestnet | Yodlee.™ All rights reserved. Technology protected by one or more U.S. Patents or Patents Pending. Use subject to license terms. May include materials developed by third parties. Yodlee and the Yodlee Logo are trademarks or registered trademarks of Envestnet | Yodlee in the U.S. and other countries. All other trademarks mentioned in this document or website are the property of their respective owners. Yodlee 621 03/17

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How to Optimize Credit Risk and Increase Lending …solutions.yodlee.com/rs/789-EJH-884/images/EB_How-to...How to Optimize Credit Risk and Increase Lending Profitability 7 As banks