The 4 Ds of Lending Value Chains in Australia
The financial services industry in Australia is currently at the cross-roads, characterised by the 4Ds: Disrupted, Disaggregated, Disintermediated, and Dogged. The acceleration of digital transformation within community-owned banks, non-bank lenders, and major financial institutions has been catalysed, at least in part, by the pandemic’s impact, which necessitated a shift toward online transactions and the digitalisation of onboarding and loan origination processes. Post-pandemic, the digitalisation of lending has evolved into an opportunity to enhance customer value by focusing on markers such as cost efficiency, value for money, and lead time to value.
Despite the reassurances from regulatory bodies like the Australian Prudential Regulation Authority (APRA) and the Reserve Bank of Australia (RBA) regarding the capital adequacy and resilience of the “Big 4” banks, a grim economic performance is projected for 2023. Growth is expected to slow down significantly to 0.7% in 2023 and 0.9% in 2024, with some quarters even anticipating a mere 0.1% growth. This economic slowdown, coupled with stress in the corporate real estate sector, suggests the country could be heading towards a soft-landing recession. Consequently, per capita output and consumer discretionary expenditures are experiencing substantial declines, while energy prices continue to soar. Furthermore, the impending challenges of rising interest rates loom large. In response, the Reserve Bank has implemented one of the most aggressive interest rate hikes in its history as a measure to counter inflation.
Transformative Evolution of Lending Value Chains: Going Beyond Origination
The slowdown in the Australian economy will have an impact on the lending and mortgage sector. The burden of heavy household debt is reducing customer demand for additional loans, resulting in a slowdown in lending sales. According to analysts from Morgan Stanley, the mortgage industry in Australia is expected to remain sluggish in 2023 and beyond, potentially leading to a stagnation of growth in the home loan market. This particularly affects regional banks, as mortgage lending is projected to decline from 9.1% growth last year to a mere 0.6% in 2023.
The dominant position of the Big 4 banks—ANZ, Westpac, NAB, and CBA—has been in a way strengthened by the consecutive interest rate increases by the RBA. Their hold on the market has increased, making it challenging for regional banks and credit unions to compete throughout the loan lifecycle. One distinct advantage of the Big 4 is the government-backed premium incorporated in their fees and NIM, which essentially makes them “too big to fail.” Furthermore, regional banks face limitations in accessing more expensive funding and have smaller marketing budgets. The challenger digital lenders are also facing tough competition from the Big 4, who are offering attractive cashbacks to entice customers who are considering refinancing.
Efficiency and customer experience improvements are expected to extend beyond loan origination and into loan lifecycle management, refinancing, servicing, collections, and collateral management. This trend may lead to potential disintermediation and consolidation within the lending industry, involving the Big 4 banks, tier two banks, customer-owned community banks and mutuals, digital challenger banks, non-bank lenders and lending fintech companies. To adapt to these changes, the lending value chain will need to be modular, agile, and detached from traditional legacy core systems and processes.
The consolidation of fintech lenders such as Nano and BNPL firms, as seen with Openpay, highlights the challenges that non-bank lenders will face. These challenges arise from a lack of wholesale funding and high interest rates. Additionally, the partnership between platform players like Lendi and major banks and broker-aggregators will create a sense of ‘co-opetition’ between banks and fintechs. In the coming years, specifically 2023 and2024, non-bank lenders are likely to encounter increasing difficulty in competing with larger banks in terms of home loan origination. This is due to the larger banks’ access to cheap deposits and prime borrowers. As a result, non-bank lenders will need to shift their focus towards digitalised interventions in areas such as loans for small businesses, peer-to-peer lending, personal event-based loans, and auto loans. They will also need to reposition their product offerings as ‘platform-based solutions’.
The Matter of Responsible Lending
Discussions and proposals are currently underway within the Federal Government regarding the extension of responsible lending obligation regulations into the ESG (Environmental, Social, and Governance) space. Financial firms are recognising the moral and fiscal importance of making a positive environmental and societal impact. This recognition stems from new regulations and changing customer behavior trends that favor initiatives with such impacts. Traditional banks are now incorporating inclusivity into their designs of financial products and services, such as Green Loans and Green Financing. They are also exploring the adoption of sustainability practices and urging customers to do the same. However, according to E&Y, only 30% of fintechs in Australia track their business sustainability or carbon footprint. Moreover, a mere 19% of fintechs focus on sustainability goals, and only 27% have implemented sustainable business practices, products, and services.
Revolutionising Lending: Embracing Evolutionary Pathways with Cutting-edge Technologies
Australian banks face numerous obstacles, including operational issues, regulatory constraints, and deeply entrenched legacy systems, hindering widespread radical digital transformation. Many banks have opted for an evolutionary approach to their digital transformation, making it challenging to enhance and personalise customer experiences dynamically. This has opened the door for fierce competition from digital-first challengers and emerging fintech companies, which are more agile and better equipped to meet the growing demands of digitally savvy customers.
On a positive note, financial institutions have recognised the imperative of pursuing digital transformation initiatives with determination, aiming to make the process less daunting and more cost-effective. Rather than adopting a rip-and-replace approach, they are focused on modernising antiquated systems. Collaborating with fintech partners to leverage their expertise in value-chain disruptive technologies such as Generative AI, Cloud, Low code/No code/AI code automation interventions is being viewed as a prudent business strategy.
The adoption of modular, lego-block-like, cloud-native lending platforms will empower lenders to unlock innovation in various areas. These platforms will facilitate seamless loan refinancing, streamlined servicing, diversification of loan products, and increased adoption of green lending products. Additionally, flexible loan models and more streamlined offset account management will further enhance the lending experience. Consequently, loan lifecycle management platforms will become more customer-centric and engender greater customer loyalty in the years to come.
The Australian financial sector is expected to face significant challenges in 2023-24. The convergence of the ‘4-Ds’ and technology-driven innovation is redefining the industry. This transformation encompasses reshaping existing services, evolving ecosystem participants, revolutionising customer service to cater to cost-conscious individuals, and harnessing the power of unstructured data to drive new avenues of growth.