uk lending: the drivers of change - target group · contents 04 executive summary 06 introduction:...

UK lending: The drivers of change

Methodology

The findings in this report are based on research undertaken by Atomik Research on behalf of Target Group.

The study was conducted in July 2015 and surveyed 100 senior finance professionals across the UK. Organisations represented in the report include banks, building societies, Peer-to-Peer (P2P) lenders and credit unions.

Annual turnovers of the companies included range from under £1 million, to over £500 million.

Contents

04 Executive summary

06 Introduction: Borrowing is back

08 Growing competition

10 The drivers of competition

11 A fair assessment of challengers?

12 Attitudes to technology

16 A danger of complacency

18 Conclusion

92% 84% 90%

What will you take away from our report?

• An understanding of the challenges lenders are facing with both consumers needs and regulation.

• A view on how lenders must evolve to meet these demands.

• Our interpretation of the real drivers of change in the UK lending market.

As a result of changing consumer expectations and increased competition lenders continue to be under pressure to improve pricing and customer experience, whilst reducing costs and driving efficiencies.

For the big banks, the danger may be one of complacency and under-estimating smaller, but nimbler competitors. Our research finds banks much more likely than other lenders to think the primary impact of new entrants is to simply push down prices, and are much less inclined to say they drive product innovation. Banks are also more likely to think current product launches (for which they still account for the majority) are driven by consumer demand, while P2P lenders are likely to think most launches are driven by marketing.

Perhaps surprisingly we discovered that big banks are more likely than

even P2P lenders to prize technology when it comes to customer engagement and underwriting. Among the banks, 95% say big data is important or very important to loan decisions, against 74% in the building society and P2P sectors. The banks – even with their formidable resources – have to work hard to overcome and adapt inflexible legacy systems as they seek to win and retain business across a wide range of channels.

New entrants start with a blank sheet, consequently giving them a tremendous advantage when it comes to tailoring systems to the demand of today’s customer. However, it also means they have neither the resources nor stores of data established competitors have built up on which to draw upon. They, too, will have to work hard – and smart – to make the best of their advantages and overcome the obstacles they face.

> 90% of respondents feel we are in a price war for lending products

> 92% agree that there is now an increased number of lending products in the market overall

> 84% of banks attribute falling lending rates to new market participants

Our survey of banks, building societies, P2P lenders and credit unions provides a snapshot of the lending industry as it comes to terms with this changing market:

Executive summaryLending markets are becoming increasingly competitive as challenger banks, Peer-to-Peer (P2P) lenders and other market disrupters look to take on established players. Allied to this, as consumer expectations change, the need for financial service organisations to review their approach to technology becomes more pressing than ever.

UK LENDING: THE DRIVERS OF CHANGE

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> Almost one in five (19%) P2P lenders think new entrants are too small to make a difference in the industry

> A more technologically-dependent market, with 79% stressing the importance of technology for customer engagement and 92% using big data

79% 92%

More than anything, though, the whitepaper looking at the drivers of change in the UK lending market shows an industry that continues to be transformed by new players and new technology.

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1. http://uk.reuters.com/article/2015/07/29/us-britain-lending-idUKKCN0Q30V120150729 2. http://cdn.budgetresponsibility.independent.gov.uk/July-2015-EFO-234224.pdf 3. http://www.bankofengland.co.uk/publications/Documents/creditconditionsreview/2015/ccr15q2.pdf 4. http://www.mortgagestrategy.co.uk/news-and-features/sectors/products/products-news/three-challenger-banks-admitted-to-the-ftse-250/2021733.article

Introduction: Borrowing is backJune 2015 saw the biggest increase in net mortgage lending since July 2008, while consumer credit grew at its quickest pace since April 20061.

The Office for Budget Responsibility expects the gross household debt-to-income ratio to pass its pre-crisis peak in 20202.

Nevertheless, mortgage approvals remain much lower than prior to the financial crisis3, and, perhaps more importantly, even if they were to regain those heights, the lending market is irrevocably altered.

The crisis and subsequent withdrawal from some lending markets by the high street banks has seen the emergence and growth of new “challenger banks”. With three now occupying positions in the FTSE 250 of the UK’s biggest businesses –a Chief Executive of one of the banks stated it is “a resounding endorsement of the extent to which they have grasped the opportunity within the specialist lending market”4.

By the end of 2013, the challengers accounted for 28.8% of annual gross mortgage lending, according to the British Bankers Association; by 2018, some predict, it may be more than half5.

28.8%


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5. https://www.bba.org.uk/wp-content/uploads/2014/06/BBA_Competition_Report_23.06_WEB_2.0.pdf 6.http://www.ft.com/intl/fastft/270342/uk-peer-peer-lending-more-than-doubles 7. http://www.thisismoney.co.uk/money/investing/article-3170073/The-3-15bn-boomtime-lend-save-savers-pour-500m-schemes-just-three-months.html#ixzz3hN2y4Q8e 8. http://www.cityam.com/219835/including-peer-peer-loans-new-nnovative-finance-isa-will-provide-boost-millions-brits

Like the challenger banks, P2P lenders have seen rapid growth, with lending more than doubling last year to more than £1.2bn6. Savers, who provide the funds for lending put £500 million into P2P schemes in the first quarter of 2015 alone, taking the total invested to £3.15bn7. Changes next April that will allow P2P loans to be wrapped in ISAs are expected to further boost the industry8.

Challenger banks, P2P lenders and the technology many rely on cannot be un-invented, and they promise to transform the industry. At the

same time, customer appetites and attitudes are changing, with ever more diverse and growing expectations in terms of communications and service channels.

In addition to exploring changes in the lending market, and gauging lenders’ attitudes to them, this white paper will also examine the impact of new lenders and their approaches to new technology. It finds an industry with few illusions about the increase in competition, but also perhaps complacency on the part of some established players as to their own competitiveness.

Likewise, while the survey finds widespread acceptance of the importance and role of technology, it also suggests challenges ahead in meeting consumer expectations in terms of what technology should deliver in their interactions with lenders.

Above all, the findings suggest a lending market that, even without the catalyst of a financial crisis, is likely to see as much if not greater change in the coming decade as in the previous one.

However, it is difficult to separate this new competition prompted by the financial crisis from the impact of technology, perhaps best typified by the rise of P2P lenders.

£1.2bn £500m £3.15bn

> Lending more than doubled last year to over £1.2bn

> Savers put £500m into P2P schemes in the first quarter of 2015

> Taking the total invested to £3.15bn

P2P growth

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This seems close to being a statement of the obvious. Mortgage rates, already at historic lows, have continued to fall this year, according to the Bank of England9. Earlier this year saw the cheapest ever fixed-rate mortgage deal10, and the average rate on new mortgages fell to 2.56% in June – another record11. Interest rates on personal loans have also seen the lowest levels since records began, according to the Bank of England, “with the low rates reflecting strong competition amongst lenders12”. Credit card issuers, meanwhile, have relaxed lending conditions by lengthening interest rate-free periods.

As one broker noted, “borrowers have never had it so good 13”.

There is little doubt that the market is more crowded when it comes to products: overall, 92% of those surveyed agreed there was an increase in products, including 90% of banks, 87% of building societies, 96% of P2P lenders, and all the credit unions. Again, this seems to simply reflect the reality: In June, the Mortgage Advice Bureau recorded that the number of mortgage products passed 14,000 for the first time in six years14.

Competitive pressure shows little sign of easing. In fact, in some markets it is likely to intensify. The introduction of tougher affordability checks under the Mortgage Market Review in April 2014, for instance, is likely to have seen many consumers in the first months remortgage with their existing lenders as it’s the simplest solution. As consumers become more familiar and comfortable with the new regime, that is unlikely to last. Whilst high street banks, meanwhile, can no longer simply rely on brand loyalty15.

Growing competition There is little doubt lenders face a competitive market, with near consensus among those questioned that the industry is in the midst of a price war in lending products. In total:

9. http://www.bankofengland.co.uk/publications/Documents/creditconditionsreview/2015/ccr15q2.pdf 10. http://www.theguardian.com/money/2015/may/01/fixed-rate-mortages-record-low-co-op-bank-1-09-two-year 11. http://www.telegraph.co.uk/finance/economics/11770654/Is-the-UK-economy-on-another-credit-fuelled-binge.html 12. http://www.bankofengland.co.uk/publications/Documents/creditconditionsreview/2015/ccr15q2.pdf


88% 100% > Of banks > Of credit unions

> Of building societies

> Of P2P lenders

90% agreed this was

the case

87% 96%

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13. http://www.theguardian.com/money/2015/may/01/fixed-rate-mortages-record-low-co-op-bank-1-09-two 14. http://www.cityam.com/221210/rush-to-remortgage-as-rate-hike-nears 15. http://pwc.blogs.com/press_room/2014/03/pwc-less-than-half-of-people-in-the-uk-are-loyal-to-their-traditional-bank.html

As a result, competition will continue to put pressure on lenders to raise standards and improve pricing, with technology central to driving process efficiencies and improved customer experience.

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Despite broad agreement on this, there are significant differences of opinion between the different types of lenders.

For the building societies and P2P lenders, more efficient underwriting is by far the most commonly cited reason for price cuts, with 55% and 60% respectively naming this as a driver. After that (with respondents able to choose more than one option), these lenders were most likely to hold low interest rates responsible, with about a quarter among both these types of lenders naming this. This was also the most popular option among credit unions, too, chosen by 57%, against 29% for more efficient underwriting.

The influx of new entrants was held responsible for the price war by only a minority of all these lenders (15% of those in building societies, 12% of P2P lenders and none of the credit unions).

For the banks, however, the picture was very different. While interest rates and efficient underwriting were also held as important factors in driving down prices (by 65% and 73%, respectively), new entrants were by far the most likely to be held responsible, with 84% attributing the increase in competition to them.

Moreover, not only do the banks think challengers and P2P lenders are driving down prices, most think this is their primary impact on the market. Asked

to choose the statement that best reflects the effect of new entrants on the market, 62% say “they drive down prices and create competition”. For building societies and the P2P lenders themselves, meanwhile, just 9% and 15%, respectively, agree that new entrants are mostly focused on reducing prices.

Instead, these players see the most important impact of the new entrants being to drive product innovation, with 61% of building societies and 65% of P2P lenders choosing this. They – correctly – see that the advantage new, smaller lenders have is their freedom from legacy systems and simple management structures.

The drivers of competitionIn fact, according to most of those surveyed the drive for efficiency is already well underway. When asked what’s behind the price war:

23

2362% 42%

44%

> Named low interest rates

> Put it down to more efficient underwriting processes

> Cited new entrants


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As the Chief Executive of Virgin Money (the challenger created from Virgin’s acquisition of Northern Rock’s business) said recently of rate drops in the mortgage market: It is the big banks trying to protect their market share, and therefore reducing their prices. The challengers were doing exactly what everyone wanted, she added: “It means competition is more acute and alive, and good for the customer16.”

However, it is difficult to argue that new entrants have not also brought innovation to the market. P2P lending itself is a clear innovation; the challengers, too, with developments in the consumer lending market, for example, have also brought genuinely new offerings.

In fact, the advantages of scale the big banks enjoy mean many new lenders have little choice but to focus either on service or innovation, rather than price, to compete. It is therefore surprising that less than a third (29%) of banks think innovation has been the defining characteristic of the new entrants, and perhaps suggests a blind spot for them.

This is reinforced by the responses when asked what is driving the proliferation of products.

For the banks, the new products address real needs, with 60% saying they are driven by consumer demand. The building societies and P2P lenders are far more sceptical, however: 65% of the former and 84% of the latter say the products are down to improved marketing (against just 37% in the banks).

This is interesting given that the big banks still dominate the market and are responsible for the majority of new launches (Halifax, for instance, brought 26 new deals to market in a single week in July17). The findings seem to imply that, as far as the banks are concerned, if anyone is driving innovation in the market it’s them. It suggests a degree of complacency on the part of the high street lenders that could prove dangerous.

A fair assessment of challengers?The banks’ belief that new entrants are driving down borrowing costs is not entirely surprising. After all, the challengers themselves have been known to take credit for the low rates being enjoyed.

16. http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/11767127/Big-banks-cut-prices-to-hit-back-at-competition-from-challengers.html 17. http://www.ftadviser.com/2015/07/24/mortgages/mortgage-products/halifax-brings-more-than-new-mortgage-rates-to-market-fpa5PfKWECEnvLQyaEykqK/article.html

> Of banks say the large number of products is down to consumer demand

> Of building societies say the large number of products is down to improved marketing

> Of P2P lenders say the large number of products is down to improved marketing

60% 65% 84%

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Attitudes to technologyCertainly banks’ engagement with technology suggests an industry that is forward thinking.

Among the banks, 90% use customer, market and publicly available data (big data) for underwriting and 93% use it to analyse customers’ interactions with their company – similar figures as for building societies (87% and 91% respectively) and for P2P lenders (92% for both purposes). This – at least in part – must explain some of the increased efficiency lenders say is driving competition (see “The Drivers of Competition”). Big data is key to achieving such efficiencies by ensuring parts of the lending decision process can be safely automated.

A majority of all lenders also agree that technology is important to their customer engagement strategies and that big data is important when deciding whether to approve a loan.

However, there are different ideas to what is important to customers when it comes to applying technology. Two-thirds of banks think the ease of obtaining a quote is the most important factor for those choosing a product, a similar proportion of building societies (65%) and P2P lenders (69%) instead prioritise the speed of underwriting and ease of obtaining a decision.

Banks also say they attach much more importance to technology – for both customer engagement and for underwriting – than other lenders. In banks, 95% say technology is either very important (64%) or important (31%) to customer engagement; for building societies it was just 74% (9% saying it was very important and 65% important), and for P2P lenders two

thirds (4% very important and 62% important). This is despite the fact that most P2P lenders’ entire business is heavily reliant on technology for sales and procurement, concentrating on the web and other online channels for sales. If P2P lenders fail to engage customers with their technology offerings, they often have no branch network or any other traditional marketing channels to fall back on.

The fact that P2P lenders are so intrinsically interwoven with technology may go some way to explaining why they assign less importance to technology than the big banks do. As Matt Hammerstein, Head of client and customer experience at Barclays recently put it at the Lendit 2015 Europe conference:

> The importance attached to technology by banks – for customer engagement

> The importance attached to technology by building societies – for customer engagement

> The importance attached to technology by P2P Lenders – for customer engagement

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23 62% 74% 95%


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“ Larger, more established P2P players make technology work for their customers, they leverage technology to create much better service experience not just a cheaper one. Banks need to get their acts together if they are to protect their market share. Banks need to move faster to make their operations less expensive so they can compete on a cost to income ratio and provide better service”

Matt Hammerstein, Barclays

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Banks are very aware that they are falling behind challenger banks and P2P lenders in this space, and are working to close this gap, before the distance becomes too great. Likewise, 95% of banks said big data was important or very important to loan decisions, against 74% in the building societies and the same proportion of the P2P lenders (where slightly more, 12%, said it was very important).

At first glance, split between traditional banks and P2P lenders in terms of the importance placed on big data seems almost counter-intuitive, and certainly many would expect the inverse. Perhaps, the rationale for this seemingly anomalous statistic lays in the fact that banks have vast stores of big

data to draw upon, and significantly more resource available to analyse it. It’s not to say that P2P lenders don’t see the value of this customer insight, but when it comes to actually making loan decisions, they neither have the catalogue of information that banks do, nor the means to tap into it. This lack of access may highlight why, as yet, these lenders fail to place more significance on this data. With the market rapidly changing, and new entrants becoming more established, eventually, they will be able to build more comprehensive data banks on customers. At this point, it is likely that attitudes towards the importance of big data will change. For P2P lenders, however, their very nature makes it more difficult for them to store such information, with their

business models being more akin to that of a broker, and data collection and retention being very light.

A third of our banking sample had a turnover above £500 million, while 88% of the P2P lenders and 73% of those in building societies were from organisations with turnovers of £50 million or less.

Bigger organisations in the survey were significantly more likely to use big data for both customer engagement and loan decisions. For both, 100% of those with turnovers above £150 million used big data, against 83% for those with turnovers of £20 million or less, and 50% or less for those with turnovers of £5 million or less.

In some ways, it is not surprising to find the banks taking the lead when it comes to utilising data. The big banks, after all, have the resources to invest in technology.

> The importance attached to big data by banks – for loan decisions

> The importance attached to big data by building societies – for loan decisions

> The importance attached to big data by P2P Lenders – for loan decisions

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23 12% 74% 95%


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Big organisations were also more likely to say technology and big data were very important to customer engagement and lending decisions: 67% of those with more than £150 million turnover, falling to 20-23% for those with £50 million or less.

This reiterates the fact that banks not only have the money to invest in technology but also have greater volumes of data to make use of. They can draw on data from a wider pool of customers, collected over a longer time in business and usually from across a bigger range of products than either the challenger banks or alternative finance providers have access to.

Anecdotal evidence suggests challengers are not blind to this advantage and the problems it presents for new entrants. The survey also supports this: While P2P lenders were more likely than the banks to recognise new entrants as a source of innovation, they were also more likely to say that the new entrants were too small to make a difference, with 19% of P2P lenders agreeing.

If new lenders are usually more innovative, they have to be if they are to level the playing field with established competitors, which can draw on deeper wells in terms of both finance and data.

100%

> Of organisations with turnovers above £150 million use big data

83% 50%

> 83% of organisations with turnovers of £20 million or less use big data for both customer engagement and loan decisions, and 50% or less for those with turnovers of £5 million or less.

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On the one hand, it would be lazy to assume that the new banks and other new market entrants are necessarily more adept at using technology to their advantage. Indeed, one recent report suggests some challengers – particularly the larger ones – can be indistinguishable from the mainstream lenders in many ways18.

However, on the other hand the hurdles facing big banks, often burdened with inflexible legacy systems, should not be underestimated. It would be equally lazy to assume the big banks’ deeper pockets and the importance they attach to technology necessarily leads to better outcomes in terms of customer process, efficiency and pricing. As noted, the survey shows the big banks have the budgets to invest in big data and customer engagement through technology.

However, this investment can be quickly absorbed with struggles to unite and mine disparate, often inflexible legacy systems. Their investments will need to be carefully applied to transform the data they do possess into usable intelligence.

Communication ambitions show the scale of the task facing banks. Asked which communication methods borrowers will prefer to use to interact with their companies by 2020, banks were spread across the range of channels from telephone (50%), post (26%) and face to face (23%), to email (83%), SMS (35%), webchat/instant messaging (76%) and social media (40%). Building societies and, particularly, P2P lenders were much more focussed: among the latter, three channels were expected to dominate: telephone (54%), text (27%) and instant messaging (also 27%),

with only small minorities naming other communication routes.

Ian Larkin, Co-Group CEO, Target Group, commented: “The communications challenge and landscape is vastly different to what it was a decade ago. In my previous role at one of the UK’s largest consumer lenders, we wrote around 90% of business through the branches and over the phone, with the bulk of this being face to face contact. The shift away from these channels will have the effect of permanently removing major barriers to entry for new lenders. This year, we have already seen the launch of the first ‘virtual bank’, with no branches or even a website for people to visit. Looking back 10, or even 5 years ago, such a concept would have seemed not just unlikely from a lender’s perspective, but potentially also unwelcome from the consumers”.

A danger of complacencyHow well banks are able to press home this advantage depends on how investments in technology are applied.

18. https://www.kpmg.com/UK/en/IssuesAndInsights/ArticlesPublications/Documents/PDF/Market%20Sector/Financial%20Services/ challenger-banking-report.pdf

> Hurdles facing big banks, often burdened with inflexible legacy systems, should not be underestimated. Their investments will need to be carefully applied to transform their data into usable intelligence


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18 See, for instance, Aviva’s digital strategy chief Tristan Brandt’s comments, in April 2014: http://www.marketingmagazine.co.uk/article/1292374/insurers-face-uphill-struggle-engage-mobile-consumers-says-aviva-digital-chief 19“New opportunities for insurers via social media”, ibid 20 The Digital Insurer: Accenture Digital Innovation Survey 2014 http://www.accenture.com/us-en/Pages/insight-insurers-seizing-opportunities-digital-transformation.aspx

If banks are to excel and compete with innovative start ups, they must do so across the broad range of channels used by the wide range of their existing customers. Unlike their nimbler competitors, they do not have the option of picking and choosing to play to their strengths.

50% Telephone

26% Post

23% Face to face

83% Email

35% SMS

76% Webchat

40% Social Media

> Borrowers preferred communication methods

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The former – particularly the smaller players and start-ups benefit from a blank slate, being able to build their systems and processes from the ground up to quickly launch new products and meet expectations. However, they also lack the depth of knowledge gained from long established customer bases and across businesses within larger groups, that the more established players can draw upon. This will prove a challenge as they look to grow.

This possibly explains the somewhat dismissive attitude of the banks to new market players – as others have suggested in relation to P2P lending:

“[As] the P2P business expands, operators will need to find riskier borrowers to lend to. The industry is already doing so, moving into areas such as small business lending where there is an appreciable need. What the bankers seem ultimately to be betting is that P2P will struggle to make this transition. It may be easy to arbitrage a few old credit card loans. But when it comes to riskier advances, whatever whizzy algorithm-based underwriting systems P2P lenders have concocted will prove no match for their own – which are based on a deep knowledge of a full range of a customer’s financial transactions19.”

Banks may also figure that regulation of P2P lending could also present a challenge for these new entrants going forward, eroding some of the nimbleness and advantages they currently benefit from. It’s a risky strategy, though. Research suggests that consumers have little hesitation in buying financial services from new providers – even those without backgrounds in financial services20 – and experience shows new lenders are expanding from their initial markets.

What should also be noted at this point, is that ‘challenger banks’ cannot be viewed as one simple, homogenous group. Various new entrants have carved out their own niches in the lending sector, with some larger players competing the in mainstream residential markets, whilst others are focusing more on specialist lending. With the market conditions over the last five years causing the big banks to focus largely on the ‘super prime’ end of the spectrum, there is room for these challengers to come to the market with innovate solutions that serve a particular area that has previously been underserved. As the economy has strengthened, however, these challengers have moved into a space where they are directly competing with the big banks. As the Chief Executive of P2P mortgage lender

ConclusionAcross lenders, the survey shows a welcome recognition of the importance of technology in improving lending decisions and customer experiences. But it also points to challenges for both new market entrants and established players.

19. http://on.ft.com/1AwKnjO 20. “Insurance Customers Would Consider Buying Insurance from Internet Giants, According to Accenture’s Global Research”, Accenture, 06 Feb 2014 http://newsroom.accenture.com/news/insurance-customers-would-consider-buying-insurance-from-internet-giants-according-to-accentures-global-research.htm. 21. http://www.ftadviser.com/2015/07/01/ifa-industry companies-and-people/p-p-lender-finds-new-funding -partner-for-further-expansion-y1cVGh3Uo30JE8kxba0tyK/article.html


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Landbay said on its recent agreement to fund specialist lending brand Keystone Buy-to-Let Mortgages: “This is not an example of an alternative financier picking up a deal that the banks don’t want; on the contrary, we are taking business that the banks would like to keep.”

He added:

“ “We can offer a fast, agile service at a lower cost than the banks we are competing with and our model means that we have the capacity to scale up rapidly21.”

Moreover, even if the impact of new entrants were only to put pressure on margins, banks must expect that this will only get worse. So far, we have only seen the first waves of challengers and disruptors in the industry. New players, including the digital-only bank Atom are yet to launch, and we’ve yet to see the full ambitions of technology companies such as Apple, which launched Apple Pay in the UK in July, or Google, a leading investor in the world’s largest P2P lender Lending Club, with which it also launched a service for its US business customers earlier this year22.

Furthermore, in this context, even efforts to branch out into social media and instant messaging could soon seem redundant, as customers turn to yet newer channels. Banks, as

well as new entrants, need to think of not just new channels and technology, but what the landscape will look like in five years’ time.

For all the upheaval we’ve seen in the industry, the challenges ahead – for new and established players alike – look no less daunting.

22. http://www.bloomberg.com/news/articles/2015-01-15/google-to-fund-business-partners-with-loans-through-lendingclub

As the late Steve Jobs once said, “You can’t just ask customers what they want and then try to give that to them. By the time you get it built, they’ll want something new.”

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