The business of lending goes back to some of the earliest written records. The fundamentals of letting someone borrow money and return it with a little extra is essentially an ancient technology.
Some financial institutions and creditors view that as proof that their business is safe from technological disruption, but that couldn’t be farther from the truth. Modern lenders will rise or fall based on their ability to integrate new technologies into their operations.
In fact, when used to their full potential, new lending technologies empower small lending institutions to compete with the big lenders—and grow their market share.
In this article, we’ll provide an overview of essential developments in lending, and how your organization can use them to maximize profit.
A Brief History of Lending Technology
While the average person may agree that “money is power,” they probably don’t consider how technology affects the movement of that power. Still, just like steam, internal combustion engines, and renewables, lending technology has transformed economies repeatedly throughout history.
The Beginnings
The archeological record provides evidence of lending as far back as the 20th century BCE—including Mesopotamian clay tablets and Vedic scriptures.
The Greeks and Romans developed their own formal systems of finance that could accommodate bills of exchange and currency conversion between civilizations, in addition to the business of lending and repayment.
The next big change was the emergence of double-entry bookkeeping in Italy at the end of the 13th century. By the 14th century, the Medici Bank represented the rise of organizations that resembled modern banks.
These institutions were able to collect and standardize information across their various branches to deal with risk and charge appropriate interest.
Even the term “underwriting” comes from the practice of a lender signing their name beneath the document, establishing their right to compensation for taking on the risk of a venture, such as a merchant sailing vessel.
The Era of Manual Processes
In 1841, Lewis Tappan created the first system of credit reporting, which proved so helpful that other merchants relied on Tappan’s system to inform their own credit decisions about customers. Over the next 120 years, retailers and financial institutions developed their own systems for evaluating consumer creditworthiness.
Their records were archived on paper files, leading to a vast, fragmented system of consumer credit scoring. These systems also discriminated deeply against women and other minority groups—discounting or ignoring reported income on the grounds of gender or race alone.
The Advent of Digital Systems and Early Automation
In 1960, there were more than 2,000 credit bureaus in the U.S., and the system was poised for a dramatic shift. As digital computers became available for enterprise use, the various credit reporting systems began consolidating.
By the 1980s, there were five credit bureaus, which soon merged into the three bureaus we still have today: Equifax, TransUnion, and Experian.
Although the Fair Isaac Corporation (FICO) got started in the late 1950s, it is not a credit reporting bureau. Rather, it provides models used to calculate credit scores, which the three main bureaus then report.
Credit reports collected basic borrower data, including borrowing history, income, and payment records. The system was largely unregulated until 1974, when Congress passed the Equal Credit Opportunity Act (ECOA), which was expanded in 1976 to prohibit credit discrimination on the grounds of race, color, religion, national origin, age, and other factors.
For the last 50 years, lenders and creditors have sought better data and analytical tools to help improve a largely manual process. Even though computerized spreadsheets were a huge improvement over analog systems, they still simulated the work of analog underwriting, falling short of what technology is fully capable of doing.
Rise of Fintech and Digital-First Lending
As modern banking fully embraced digital core software and high-speed data networks, they improved the speed and accuracy of their application and underwriting processes.
It’s helpful to think of lending technology as progressing from highly subjective (i.e., character-based) lending decisions, to more objective and verifiable lending criteria such as income, employment, and credit history.
Today, people seeking credit can do so from the comfort of their home or office. The variety of credit products is larger than ever, and the types of data used to assess creditworthiness have also grown by leaps and bounds.
While credit scores still provide the backbone of most evaluations, artificial intelligence and open banking technology have unlocked new frontiers for financial institutions and creditors.
The Technology Behind Digital Transformation
Even if it appears primitive—as in the case of tally sticks—technology has driven the process of lending.
Today, there are four technologies driving the business of lending forward:
Artificial Intelligence (AI) and Machine Learning (ML)
Lending is a risky business, which requires a detailed assessment of the borrower’s ability to pay back. Using AI in lending allows creditors to process vast troves of fundamental indicator data (such as income, credit score, and credit history) faster, and learn to spot new indicators for creditworthiness.
Cloud Computing
Before the world was hyper connected, it was difficult to maintain a single source of truth for a consumer’s creditworthiness. Data centers have allowed organizations to store consumer records in a virtual “central” location, making them accessible 24/7. This has paved the way for that data to be processed in novel ways that help creditors make better decisions.
Big Data and Analytics
Powered by ready access to reliable, affordable, and central data storage, organizations are keeping more data and doing more with it. More companies are developing innovative ways to analyze consumer data to identify opportunities and hidden risks.
Application Programming Interfaces (APIs)
Technological progress travels on the road paved by standardization. APIs allow third-party vendors to develop new products and services that can easily and securely interface with each other.
How Lending Technology Can Power Small Lenders
97.1% of Americans use the internet. That’s up from practically zero in 1990. It’s woven into nearly every aspect of our life, making it more of a utility than a luxury, as the 2020 pandemic proved beyond a shadow of a doubt.
The digital lending space is highly competitive and getting more so every year. That means that lenders also have lots of technology solutions to choose from, but less clarity about which solutions will improve their bottom line.
To help clear the noise, here are some of the areas where lenders should leverage new technologies.
Borrower Experience
By digitizing their processes, lenders can streamline and speed up the application and borrowing experience. Rather than submit reams of paperwork, potential borrowers can fill out an online application and connect their bank account/s for verification.
Lenders can use that data to customize products for new markets, such as gig workers and underserved communities. Borrowers want to complete credit applications at their convenience, and to see that lenders are using technology to make everything simpler and less stressful.
Operational Efficiency
When you deploy the right lending technology, it also helps your staff do their best work quickly and with minimal errors.
Modern lending technology allows you to reduce the manual workload, including application processing, document handling, and compliance. You can also use it to consolidate servicing, collections, and payment management
Use of Data
Networks and APIs allow lenders to collect a greater volume and variety of data than ever before. For example, it is now possible to analyze transaction data and look for patterns in applicant behavior that would have been invisible before.
This stream of data also enables lenders to monitor a borrower’s financial health in real time and make adjustments to increase the likelihood of full repayment. Lenders can use data to better forecast demand, accurately gauge risk, and optimize their credit offerings to each individual applicant.
Scalability and Adaptability
When your lending process is based on manual processes, you can’t scale effectively. Even if you can bring in more borrowers, you need qualified lending and compliance officers to handle the workload.
Advanced lending technology makes it possible to process applications faster and with better accuracy. Each member of your staff can handle a higher volume of applications with fewer errors.
This means that you can also bring new products to market faster and with a better market fit.
Compliance and Risk Management
Once your lending process is fully optimized and streamlined, the work of regulatory compliance is simpler than ever.
Software automation allows you to establish compliant processes that everyone follows because they’re working from the same source of truth. You can also update the automations as new regulations are released.
Using AI-powered analytics and fraud protection, you can monitor risk and squash suspicious behavior before it causes problems.
Underwriting Accuracy
One of the biggest challenges for organizations that want to offer credit to underserved communities or niche industries, such as gig workers, is the “thin file,” meaning insufficient credit history to satisfy standard underwriting protocols.
Armed with the right AI tools, your team can analyze disparate data points, including utility payments and alternative income sources. While conventional analytics often miss the relevant data that’s sitting in their transaction history, alternative financial behaviors can help complete the picture of a borrower’s creditworthiness.
In fact, conventional methods of borrower analysis often misidentify which applicants are high and low risk, leading to overlending and underlending. Instead, AI-driven underwriting helps you “right-size” every loan and create more satisfied customers.
Advanced Bank Verification™ Brings It Together
Borrower data is available to every organization that offers credit to consumers or needs to assess creditworthiness. But few companies can make full use of it.
Most institutions use instant bank verification (IBV) to check an applicant’s relationship with a bank and transaction history. It reduces paperwork and human error, while giving lenders access to a valuable data resource.
IBV represents a huge leap forward in lending efficiency, but it’s limited in scope and performance. It allows underwriters to almost instantly verify essential details about a borrower’s financial life, but it isn’t able to fully interpret transaction histories, and frequently misses items that greatly affect creditworthiness—such as alternative income or payments to other lenders.
That’s why the lending industry needs the next generation of technology to evaluate creditworthiness: Advanced Bank Verification™, or ABV.
Using ABV technology allows your organization to quickly decode all of an applicant’s data and integrate those findings into your existing workflow. This includes:
- Validating identity and accounts: Automatically analyze bank and card transactions to get the most up-to-date, accurate picture of borrower income and ability to pay.
- Identifying hidden loan risks: Flag payments to existing lenders and other behaviors, such as over-reported income, that indicate a higher likelihood of default, allowing you to price loans more accurately and avoid problematic borrowers altogether.
- Optimizing loan amount recommendations: Once you have a comprehensive picture of a borrower’s finances, you can better calibrate the size of the loan you offer to their needs and ability to repay.
- Establishing optimal payment schedule: Especially for applicants who have alternative income sources, it can be difficult to pick the optimal payment due date. ABV allows you to precisely choose a due date when the borrower is most likely to pay.
- Identifying star customers: Better data analysis and lifecycle reporting help you find the best candidates for additional credit or loan products.
- Streamlining and improving collections: Collections are a tough but necessary part of any lending operation. ABV technology can help simplify your collection process and create optimal outreach schedules—improving recovery and reducing the burden on your staff.
By adopting ABV as your new verification standard, you get way more than just a better borrower assessment. You get better data connectivity, useful insights, and a clear set of levers you can use to improve profitability—across the entire lifecycle of the loan and the borrower.
The Future of Lending Technology
While we don’t have a crystal ball to see how the business of lending will change in the near and far future, we can use some current trends as decent indicators.
Expect major improvements for borrowers and lenders alike—along with stiff competition from organizations that are willing to deploy new tech aggressively.
Embedded Finance
Financial technology has made it possible to bring financial products into the (non-financial) digital interfaces of everyday life: buy now, pay later is just one example. Offering credit to small business owners through an e-commerce platform is another.
Embedded finance increases the opportunities for finding prospective borrowers, as you meet them where they are—as opposed to waiting for them to come to you.
Tools like ABV will make it possible to assess creditworthiness in these non-financial situations—and extending credit to a person in need is a great way to build customer loyalty.
Blockchain and Decentralized Finance (DeFi)
While cryptocurrency isn’t likely to replace the global financial system, it does offer a set of features and possibilities that centralized currencies can’t compete with.
Fundamentally, blockchain is a decentralized, cryptography-based ledger of transactions stored across a network of computers. This ensures transparency, verifiability, and resistance to fraud. Although regulators are still forming policies and rules for how blockchain can be integrated into the financial system, the power of DeFi is here to stay.
One of the remarkable features that blockchain has is the ability to create smart contracts that execute the terms of an agreement (i.e. a loan) as soon as certain conditions are met. This can include interest calculations and repayment.
While consumers are bullish on the possibilities for DeFi, it remains to be seen how mainstream (aka, highly regulated) lenders will incorporate it into their product offerings and workflows.
Cybersecurity and Fraud Prevention
The fight against cybercriminals is grim. Due to the incentives of preying on vulnerable internet users, cybercriminals can leverage new technologies much faster and profitably than cybersecurity companies can fight back.
Lenders and financial institutions should maintain an aggressive approach to monitoring and combating cybercrime within their ecosystems. AI-powered cybersecurity solutions are helping stem the torrent of fraud and theft, but no lender can afford to be complacent. If borrowers are willing to trust you with their transaction data, they will expect you to protect it.
Responsible Lending and Financial Inclusion
Although the ECOA is more than 50 years old, financial technology companies and lenders are still grappling with their responsibility to extend credit equitably and without discrimination.
Today’s best practices for assessing creditworthiness are bound to overlook qualified borrowers because they only use data at a superficial level.
If creditors are going to reach underserved communities and provide responsible financing, they’ll need the most comprehensive picture they can get—something FICO scoring simply can’t provide.
The key is to feed all the disparate data points from each borrower into an intelligent model that knows how to build the right loan for each person and create the best scenario for repayment. ABV is paving the way towards that goal.
Lending Technology Is Advancing Fast. Will You Keep Up?
If an economy can’t provide enough sustainable credit to businesses and consumers, it grinds to a halt. That friction is what inspired Lewis Tappan to create the first credit scoring system.
Responsible debt is a powerful mechanism for growth and prosperity. It’s an “old” technology that is more valuable than ever.
Unfortunately, IBV and conventional lending practices cause many lenders to miss the mark with their borrowers—taking on too much risk and overlooking qualified applicants who don’t “fit the mold.”
That’s why ABV is so critical for the next era of lending. It has the potential to change underwriting and decisioning the same way that Lewis Tappan’s system did back in 1841.
Today, ABV from Bankuity is opening up new markets and levers for profitable lending.
Bankuity can help your organization strengthen your existing market position, extend your reach, and see your entire lending operation with unprecedented clarity and precision.
