Online Lenders in the U.S. are Reducing Risk Exposure and Recession-Proofing

2 minutes

Recently, online digital lenders like LendingClub, SoFi, and BlueVine have begun preparing to face the uncertainty of an economic downturn after an increase in concerns over the peer-to-peer and marketplace lending industry’s ability to withstand these stresses.

As a whole, marketplace lending and peer-to-peer lending networks were a response to the credit liquidity crunch following the Great Recession, so they haven’t experienced a true “stress test” of their business models yet.

Making Changes to Reduce Risk and Recession-Proof

An economic downturn or recession could lead to increased losses (in the event of defaults), decreased availability of funds to lend, and higher costs to create loans in the first place. These are all valid concerns for an industry that relies on market funding to connect investors with borrowers. Unlike banks who often rely on a steady stream of deposits for liquidity, for marketplace lenders, funds can be harder to come by in times of economic stress. Here are the three main changes that online lenders are making to recession-proof their business models:

  1. Focusing on loan quality and underwriting standards
  2. Securing long-term financing
  3. Cutting costs per loan and reducing overhead

These lending platforms have relied on some non-traditional underwriting methods, utilizing data that hasn’t been widely tested in predicting creditworthiness in the past. Factors like your education level, shopping behaviors, and even information derived from your social media presence are all being used to try and figure out how much of a credit risk you might be.

No Signs of Trouble, So Far

Even though online lenders aren’t seeing signs of trouble when it comes to investor confidence and loan performance, many have chosen to prepare for future economic uncertainty — hinted at by the Federal Reserve recently when they chose not to hike interest rates any further at their March meeting.

“This is very top of mind for us,” LendingClub CEO Scott Sanborn said in a recent interview with Reuters, referring to the possibility of an economic recession. “It’s not a question of ‘if,’ it’s ‘when,’ and it’s not five years away.”

By incorporating more sound lending practices and cutting costs, lenders are hoping to strengthen their businesses for the future, even if it comes at the cost of revenue today. Its a simple fact that they may originate fewer loans by tightening their credit standards, but companies like SoFi and Avant have decided they are willing to make the tradeoff.

In order to secure capital (i.e. money to lend), online lenders borrow and pay interest on that money as well. Securing longer term funding is obviously more expensive to do, but important to the stability of the industry.

Expected Impact to Borrowers

In an effort to avoid a credit crunch in the future, where funds to lend dry up and loans aren’t readily available, qualifying criteria are being more closely scrutinized and interest rates for higher risk categories may climb as a result. However, not all lenders will evaluate and interpret your financial scenario the same way, so it pays to compare your options before deciding on a lender and a loan product.

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