The State Of Customized Lending

Sean Hunter, Chief Information Officer at OakNorth

Sean Hunter, Chief Information Officer at OakNorth

1. Why are customised lending solutions for SMEs gaining importance?

Providing SMEs with customized lending solutions is something that has always been important, it’s just not always been possible from an economics perspective.

If you are an individual or a small or medium-sized business aiming to borrow a few thousand to a few hundred thousand dollars, technology has made it possible for lenders to provide an extremely efficient service and for you to get a near-instantaneous credit decision.

For larger or more complex loans however (i.e. loans of $1m to $25m USD) it remains a fundamentally manual and expensive process. A bank given the choice of issuing a loan of $100m with a 1% arrangement fee, delivering $1m in fees, or issuing a loan of $10m with a 1% arrangement fee, delivering $100k in fees, will naturally focus on the bigger deal, meaning the likelihood of the smaller loan getting a customised facility is not very high. In the mid-market, where loans are too big for automated decision models but too small for the unit economics of the manual approach to make commercial sense, the market has been characterised by fairly inflexible, product-centric lending which does not necessarily meet borrowers' needs.

“When it comes to commercial lending, banks rely on risk models to make decisions”

2. What role does AI play in providing customized debt financing?

While a fully-automated decision process will probably never be appropriate for loans in the millions of dollars, artificial intelligence and largescale data analysis can help bridge the gap between fully automated and fully manual credit assessment, allowing an efficient, semi-automated process while still preserving some of the customisation necessary to address the complex needs of small and medium-sized businesses.

3. What other disruptive technologies are finding favour in the financial industry?

AI, ML and large-scale data analysis (also sometimes known as ‘Big Data’) are all disruptive technologies having an ever-increasing impact on the financial industry.

4. What are the current shortcomings/challenges in the commercial lending sector?

When it comes to commercial lending, banks rely on risk models to make decisions. These models have been built up internally over decades of lending across thousands, if not tens of thousands of loans, but COVID-19 has exposed unexpected shortcomings in them.

The first issue is that these models are based on historic data which doesn’t adequately reflect the unique situation we now find ourselves in or take into account the future challenges that the world will be facing as it enters into the worst recession in three centuries. The second issue is that they make broad assumptions about entire sectors rather than developing an understanding of the portfolio at the granular loan level and taking into account the individuality of each business. The third and final issue is that these models don’t take into account how quickly the situation is changing.

5. Given the current pandemic, how is the commercial lending industry coping?

Historically, banks and commercial lenders have relied on a small number of monolithic suppliers and systems to provide them with broad capabilities, augmenting their own internal development, to provide all their infrastructure. These systems are patched to add features as banks grow and markets evolve. Mergers can lead to overlapping, incompatible systems; the bank’s infrastructure can make these systems brittle, costly and time-consuming to change.

Covid-19 and the subsequent government interventions, however, are forcing banks to move quickly: multi-year projects would never adequately address the emergency needs of customers and existential challenges of businesses. The crisis comes at a seminal moment for the industry, when many banks are beginning to experiment with cloud infrastructure. These solutions are able to provision (or decommission) infrastructure in seconds what previously would have taken years, and are well suited for rapid experimentation.

The extraordinary circumstances brought about by the pandemic have led to a moment of unique opportunity for both banks and fintechs. The economic environment and policy responses by the federal government has meant that banks are forced to act with surprising resourcefulness and agility. They are now seeking to carry this momentum to radically transform projects that seemed previously destined to move at a snail's pace.

To do this at speed and at scale, they have had to look beyond the short list of traditional vendors and implementation partners more accustomed to project timelines of several years, to a constellation of smaller, more agile fintechs that are able to meet specific needs at a rapid pace. The Davids and Goliaths are finally working together - so far, the outcomes have been pretty phenomenal.