By Mark Richards.
The world of banking is changing – but right now no part of it is changing more fundamentally than loans. Mobile phone apps and the ever more sophisticated use of information means that loans can increasingly be tailored to a customer’s changing credit profile. We take a look at what’s happening…
Over the last year, we have consistently written that the traditional retail banking sector is due for a huge shakeup. Five years ago there were ten bank branches in the town where I live: with RBS closing recently there are now five. By, say, 2022? I suspect that number might be down to two or three.
The problem for the banks is that whatever they did – loans, current accounts, insurance – someone else now specialises in it and does it better, faster and cheaper, and without the need for high street premises.
Nowhere is this truer than with regard to loans. Mobile phone apps and more sophisticated use of ever-increasing amounts of data mean that new-style lenders can offer better, more flexible and cheaper loans to people who need them.
The bad old days
But first, let us look back to how loans used to be – and with some lenders, still are.
Let us say that back in 2012 I was off work for a long time due to an accident or illness. Or maybe I lost my job. Perhaps there were problems in my marriage and life went off course for a while.
All three of those scenarios would almost certainly have led to problems managing my money. I could have made late payments, defaulted on some loans or found myself with County Court Judgements.
Fast forward to 2018: I am in perfect health, I have a steady job and I am happily married. A lot can change in six years – but what will not have changed are those problems from 2012. They will still be on my credit file, and if I want to get a loan or a mortgage, the lender is going to want answers – and may well charge me a higher rate of interest because I am seen as a ‘bad risk.’
Far too many lenders operated on that simple principle: a leopard did not change its spots. If someone has had financial problems in the past then they are likely to have them again, and if they are looking for a loan or credit then they are going to have to pay a higher price to compensate the lender for the higher risk.
In fairness, some lenders have started to take a more flexible approach of late, being prepared to look at reasonable explanations for past problems and perhaps discount some of them. But to date, one thing has not changed: the interest rate I was being charged at the beginning of the loan would be the interest rate I was paying at the end of the loan. To use that example, if I had taken out a three-year loan the financial problems I had in 2012 could determine the interest rate I was paying in 2021.
Welcome to the ‘dynamic loan’
Clearly, the scenario I have outlined above is unfair. Given all the sophisticated data analysis now available, surely the interest rate you are paying could adapt as you make regular payments on your loan and improve your credit score? That is what one of the ‘challenger banks’ is now proposing.
Developed by Chetwoods Financial in conjunction with credit ratings agency Clearscore and launched under its brand Livelend, the loan uses technology to monitor a customer’s credit score and reduces the interest rate – at three-month intervals – as that credit score improves.
As the boss of one of the challenger banks said, “We are conscious that this [new loan] will meet a demand for loans with people with affordability issues.” With even traditional banking heavyweights such as JP Morgan looking at ways to ‘reward customers for boosting their credit scores’ the loans market is now going the same way as the whole banking industry. What was previously set in stone is rapidly being overtaken by new technology.
How will this impact the short term loans industry?
It is no secret that the short term loans industry has received a bad press. It is an easy target for headline writers but, as we have written many times, there a plenty of occasions when a short term loan makes a lot of sense – and is certainly preferable to the fees charged by the high street banks for unauthorised overdrafts.
So how will the industry be impacted by the new technology and ‘dynamic’ loans? The signs – for both the industry and its customers – are favourable as even ‘hot new start-ups’ such as Monzo consider moving into the market.
There will always be people with little or no credit history – migrant workers are a good example – and there are around 1.6m working adults in the UK who are ‘unbanked.’ That is, they do not have access to a bank account.
And yet clearly these people will occasionally need access to short term credit – whether it is to fix the car so they can get to work or, inevitably, making sure the children have some sort of Christmas.
Dynamic loans will become more dynamic
There is no doubt at all the loans will continue to become more responsive to a customer’s changing needs and circumstances. We are also likely to see moves towards the ‘gamification’ (applying elements of game design to products which are anything but games) of financial products, which could see customers rewarded for making payments on time – as opposed to the traditional model of punishment for late payment.
Rewards might take the form of building up a cashback sum or earning a lower rate of interest. And yes, while the rewards will obviously be built into the cost of the product, surely it is better to have something with positive, not negative, reinforcement?
We have written previously that you can regulate supply but you cannot regulate demand. There will always be a need for short term loans: companies that meet the demand with innovative products will find a ready market. Just as importantly, they will be doing their customers a valuable service.