The relationship between fintechs and community banks has evolved in recent years, shifting between collaboration and competition. Those who have turned to fintech partnerships to bolster unsecured loan portfolio growth must now manage potential losses and financial stability in the current economic landscape.
Looking ahead to the remainder of 2024, high inflation rates are causing elevated interest rates along with major financial institutions reporting surging delinquency rates across installment loans and credit cards. This prospect poses a concerning threat as increasing numbers of households and small enterprises may struggle to keep up with debt obligations.
During and after the pandemic, community banks seized the lucrative opportunity presented by unsecured consumer credit. Low interest rates made it cheaper for banks to obtain capital, allowing institutions to offer competitive rates while still earning significant returns. Demand for unsecured credit products also increased as consumers faced disrupted finances and used government stimulus checks to bridge cash flow gaps, masking underlying credit risks.
To accelerate portfolio growth, many banks bought loans from fintech lenders, bypassing the time and resource investments required to generate organic loan growth. However, the economic landscape has since shifted, with rising inflation and interest rates potentially causing financial strains on consumers and increasing risks in the unsecured credit space.
For those who expanded their unsecured lending portfolios through fintech partnerships, the looming debt crisis could expose them to significant losses. Fintechs often provided unsecured credit to near-prime applicants not qualified for traditional loans and charged banks lucrative fees based on loan origination amounts, creating a profit incentive that might have led to over-extension of the credit risk box.
Consequently, those now holding these loans could face financial difficulties as the credit market and economic outlook deteriorate. With 2023 credit performance showing headwinds from historically low levels and rising charge-offs, institutions must bolster internal risk management processes, rather than relying on the fintechs that sold and service the loans.
Quarterly disclosures from fintech loan facilitators like Prosper indicate early delinquency rates for newer loans originated in 2022-23 of around 3 percent and total loss rates of around 7 percent, with expectations of further increases. Additionally, 2024 quarterly reports from banks partnered with Upstart show increasing delinquency rates across loan categories. Customers Bank reported a 6.4 percent installment lifetime loss rate, while First National Bank of Omaha disclosed delinquency rates of 1.6 percent for credit cards and 2.9 percent for revolving credit plans. These elevated delinquency rates serve as early indicators of financial strains within the current economic climate.
Community banks face a critical juncture as they navigate the challenges of inorganic loan growth within high delinquency markets. The consequences could be severe. In the best-case scenario of reducing inflationary trends and interest rate stabilization, well-prepared community banks have transformative opportunities to become more risk-aware and implement proactive stability measures. They could reduce the acquisition of fintech-originated loans, which often carry higher credit risks. Prioritizing organic loan growth will allow for more control over risk exposure. Increasing loss reserves is another strategy. Recent increased provisions for the federal banking system and smaller banks reflect industry-wide expectations for higher loan losses, signaling the need to build up loss reserves for long-term financial resilience. Finally, implementing rigorous monitoring to track unsecured loan performance and detect early signs of delinquency is crucial. They should segment risky customer cohorts to identify risk overexposure and implement specific interventions.
As community banks rebuild their lending books, the organic growth route presents a promising strategy. With the latest advances in digital decision management tech, with emphasis on automation, standardization and plug-play data infrastructure, smaller financial institutions are positioned to build world-class decision capabilities with a small team of specialists, without needing to outsource this critical function.
Moreover, this approach enables them to develop capabilities efficiently and economically, establishing a scalable customer and loss management capability on the same foundation.
Aditya Khandekar, chief revenue officer at Corridor Platforms, specializes in AI-driven products, fraud prevention, credit risk and banking compliance. If you wish to explore these issues in more detail or have questions about the implications for your bank, please contact Aditya at [email protected]