Are banks heading down the same path as fintechs? It appears this is the case. For the longest time, banks stayed away from extending personal loans to consumers due to the high risk they posed. Banks occupied the personal loan space, but fintechs took over the baton.
Consumers with poor credit scores posed a great risk to banks and since personal loans are unsecured loans, the risk is greater. Fintechs became the go-to-guys for quick personal loans, especially for those who felt sidelined by banks.
However, the banks are back, and they want their rightful place as lenders. Most of these banks have online platforms where they engage their consumers by promoting their products. One of them is personal loans.
They are back with a bang, but what are the risks involved? Data from TransUnion shows a growing personal debt, with the current figure at $132 billion for the third quarter. This represents a 59 percent growth in only three years and a $12 billion rise from the first quarter.
These are huge leaps, but the worrying trend is tied to how Americans use the loans. Instead of clearing any outstanding debt, the loans end up fueling consumption. The unemployment rates in the U.S. remain low, and lenders can take on losses from personal loans.
However, if the economy hits turbulence, the loans will go bad.
Bad Loans
According to data from TransUnion, banks, non-banks, and credit unions have outstanding, meaning loans that are not being paid back, personal loans totaling $20.3 million at the close of the third quarter. This represents a 42 percent increase compared to the same period three years ago.
However, banks don’t seem perturbed by the figures saying that all their lenders meet their criteria, including stellar credit scores. This is different from online lenders who don’t use credit scores as a filter. Nevertheless, the track records of these prime borrowers can only go so far, presenting uncertainties about how the loans will behave during an economic storm.
Subprime borrowers constituted a huge percentage of personal loan beneficiaries in the past, but after the financial crisis, the personal loan space took its last breath. Online lenders including Prosper, LendingClub and Avant soon revived the space.
These lenders offered borrowers lenient terms compared to banks. Loan applications took a fraction of the time that banks took, and it was easy and fast. It was only a matter of time until banks realized the opportunity and flocked to that space.
Among the pioneer banks are SunTrust Banks, based in Atlanta, and it has its branches operating in the Southeast. Their online platform, LightStream, targets borrowers with good to stellar credit.
The online platform started operations in 2013 and from then, the platform has raked in $7.5 billion worth of loans. The nation 21 loans cover a variety of services and goods, from medical procedures to recreational equipment. In addition, they fund consumers who place low-cost deposits, something other banks use to lure consumers in a bid to stay ahead of the competition.
BBVA Compass followed in the footsteps of SunTrust and launched Express Personal Loan, an online platform. Customers can borrow up to $35,000 with a repayment period spanning up to six years. In addition, customers can get cash in under 24 hours.
Due to high internet penetration, consumers want more services online. In fact, if you aren’t online, you’re missing out. Goldman Sachs operates an online lending platform called Marcus and offers loans as high as $40,000 with APRs starting from 6.99% to 24.99%.
According to Lloyd Blankfein, a retired company CEO, Goldman looks to join the table and share the profits with other big lenders.
Americans are Borrowing More
A booming economy is the main reason why Americans resort to borrowing. Put into figures, this huge appetite translates into $1.04 trillion owed. Another reason is the lack of collateral to take out personal loans.
This makes it fast to approve the loans since there’s no need to seek the services of a valuer which requires additional paperwork. Speaking of paperwork, online lenders conduct their business online, thus cutting down the customers’ trips to the bank.
On top of this, rising interest rates provide fodder for borrowers seeking personal loans. A person who is paying high rates to borrow money has the option to consolidate the debt at low rates. For example, if a consumer is paying 17 percent on their credit card, they have an option of reducing these rates to 10% or 9% by taking out a personal loan.
The main reason why a huge percentage of borrowers seek personal loans is to consolidate debt. However, once the borrower has the cash at hand, it’s impossible to follow them to know how they spend the money. Some end up spending the money to buy boats or cars or to pay for home repairs and improvements, etc.
The main question that comes to mind is who is fueling the aggressive personal loan appetite? The borrower takes the blame, but shouldn’t the lenders also have restrictions to prevent borrowers from borrowing more than they can repay?
Instead, the lenders do the opposite. After you take out a loan, some lenders will push you into borrowing more in order to refinance the current the loan or fund other activities.
Tighter Terms
Discover Financial Services issued warnings around declining credit quality. As a result, lenders are tightening their terms, especially on personal loans. On the other hand, Goldman Sachs has since cut down its 2019 target for loan origination due to the same concerns raised by Discover.
Many lenders are in competition to offer loans to borrowers. Due to the stiff competition, lenders are turning a blind eye on their rules by qualifying customers with poor credit scores, despite the risks involved.
However, not all banks pardon irresponsible borrowing, which could lead to massive losses. Some of them have better risk management techniques than others.
Turbulent Times Ahead
A debt crisis hit Americans 10 years ago. This is not the case at the moment. Borrowers can afford to pay back loans, and they can take out as much as they want. However, turbulent times loom ahead and this will be the true test.
The current crop of online lenders might not have seen the wrath of a recession, but most of them seem prepared. One of the measures taken to secure the lenders against harsh economic times is by hiring seasoned financial experts who have an idea of how to navigate a recession.
The Bottom Line
Banks might have pumped the brakes after the credit crisis, but they are back and overflowing with generosity in the personal loan space. Nevertheless, space remains competitive with the online lenders putting up a spirited fight.
On the other hand, a number of lenders are finding it difficult to filter out applicants who pose a huge risk to them. The growing appetite from borrowers and the welcoming arms from lenders is opening doors to multiple applications.
This is a risk because lenders get to realize these debts piling up only after approval. Fintechs have an advantage over banks. When the banks took a break from personal loan lending, the online lenders took time to gather useful information about their borrowers.
Thanks to advances in technology, online lenders can collect information from various sectors including social media platforms such as Google, Twitter, Facebook, LinkedIn, and Yahoo.
According to LightStream 15 percent of American adults carry personal loans, 43 percent have credit card debts, 16 percent have student loans, and 32 percent have mortgages.
With these figures, experts predict a rise in the demand for personal loans based on the market and its potential. This will also set up more debt for consumers in the future.
