Where traditional and tech meet How banks and marketplace lenders can partner up

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1 Where traditional and tech meet How banks and marketplace lenders can partner up August 2015

2 Where traditional and tech meet What is it that would cause today s consumers to turn to a new company for their borrowing needs? Why are technology startups taking on some of the largest and most established financial institutions in the world for the job of allocating capital? These questions speak to the changing cultural and technological landscape that is starting to impact the financial services industry from the smallest players to the largest banks. Not long ago, the question was what would the traditional lenders response be to all of this? Would they compete or collaborate? Today, we see institutions taking both routes, with an increasing number of established lenders choosing to collaborate with new marketplace lending entrants. This collaboration began with loan funding agreements: a bank funds the loans originated by a platform and then sells the loans back to the platform, along with agreements for banks to invest in marketplace loans, purchasing loans that fit their credit profile. Today the question becomes: which banks will be the first to truly capitalize on the deeper opportunities that these partnerships have the ability to open up? Marketplace lenders are often seen as disrupters competing against traditional banks. Several of them focus on innovative technology and rapid service, and the companies are attracting a whole new segment of consumers who are not necessarily the core strength of traditional lenders. Yet, the more traditional banks have lower cost of funds, a long history of consumer lending and credit modeling, significant investments in customer relationships and branch networks, well-known brands, and access to decades of customer data. These complementary attributes open up the opportunity for true strategic partnerships between traditional and marketplace lenders. Some believe that Lending as a Service (LaaS) 1 will be the model of the future, utilizing the most efficient parts of each company s operations or technology platform to create superior loan products that offer the best prices and service to customers. As banks progress beyond simply investing in marketplace loans, these partnerships will take many forms, from basic referral programs to white labeling and joint product development. Each type of partnership has the opportunity for significant revenue benefits to each side (and their customers!) and requires a different level of integration and investment. 1 Rotman, Frank. The Hourglass Effect, A Decade of Displacement PwC 1

3 While the potential benefits are clear higher returns, access to new customers, and fulfillment of obligations such as Community Reinvestment Act(CRA), there are a few reasons why some banks have not yet pursued partnerships with marketplace lenders. These include limited risk appetite, potential cannibalization of the bank s own business, and perceived potential reputational risks. Whichever type of partnership is pursued, there will be a need foradditional due diligence and scrutiny beyond what is typically expected from pure investor partners. Banks have certain regulations to comply with which marketplace lenders are not directly subject to, and banks will need insight into the complexities and workings of marketplace lenders. Choosing the right partner to fit a bank s strategic needs and establishing a comprehensive framework to manage the relationship are critical to achieving synergy and success. Below are a few examples of recent partnerships between marketplace and traditional lenders. Recent examples of partnering up PwC 2

4 Partnering to lend capitalizing on strengths Most marketplace lending partnerships will begin with a financial firm or bank purchasing loans from a marketplace lending platform based on established criteria that match the bank s risk and return objectives with profiles and volumesthe platform is able to produce. As the partnership matures, the partners become more comfortable and familiar with each other and more strategic opportunities are identified, leading to additional depth and integration. Lending as a Service) may be the model of the future; banks and platforms would each identify their core competencies and areas of opportunity and then determine the best mix of services that each can provide. For example, they could work together on attracting new customers: the marketplace lender can be responsible for the application, underwriting, closing, and credit modeling process, while the traditional lender might use its scale and expertise to handle servicing and collections functions, identify opportunities to cross-sell products and services, and provide financial advice to the customers. Customer Acquisition Application, Underwriting, Closing Credit modeling process Servicing and collections PwC 3

5 Referral programs Customer Acquisition A form of partnership beyond buying loans is a referral program wherein banks and marketplace lenders refer prospective borrowers to each other. When a potential customer applies for a loan but does not fit the credit profile or other specifications of one lender, that customer can be referred to the other lender. This may involve an initial decline, with the lead then passed to the other lender, or the borrower presented with contact information for the alternate lender. Ideally though, this process would be a seamless transition wherein the borrower would be redirected within the online application to a co-branded partner website that presents the borrower with their loan options and next steps. Consideration should be given to borrower experience and messaging, alignment of the speed of funding and other parameters with regards to the original loan, and to privacy and data sharing requirements. While such referral programs can create fee revenue, they can also allow banks and lenders to provide a more full-service offering to meet their customers needs. Imagine, Jacob has been operating a wildly popular food truck for the past year and is looking for a $25k loan to purchase another truck to expand his business. He walks into the local branch of the bank where he has his checking account and mortgage loan to discuss his options. Banker Mary tells him that while the bank only make loans to businesses with at least two years of operating history, its lending partner has some great business and personal loan products. She shares the details of the partner programs, along with some promotional materials. When Jacob finishes asking questions and says that the partner s loans sound like they will meet his needs, Mary hands him a tablet and brings up the loan application screen. Jacob spends about 15 minutes at the branch inputting relevant information, with Mary helping to answer questions along the way. The bank receives a referral fee from the platform, along with the benefit of having helped one of its loyal customers meet his financial needs. Through his various interactions with Mary, Jacob realizes that he could significantly lower his credit card processing costs by moving over to the bank, and he eventually also moves his investment accounts. PwC 4

6 White labeling Application, Underwriting, Closing White labeling is a deeper form of partnership in which the platform provides technology to act as a virtual extension of the bank. These partnership may be effective when a bank has little to no current presence in a lending asset class, or when an institution doesn t have the budget to start up a new business line that would require significant investment in technology and operations. White label partnerships could be developed to handle the loan process from beginning to end, including customer acquisition, processing, and servicing functions, or might only involve a technology layer to support a bank s own marketing and processes. From a customer experience perspective, that platform is the bank. Because of that, there are significant implications in terms of service quality, branding cohesiveness, and compliance considerations. Yet, from an operational perspective, the two entities still operate separately and must skillfully navigate complex workflows which touch both parties. Imagine, Jane is about to start her first job and is moving across the country for it, but she needs some extra cash to pay for moving expenses quickly. She knows just where to look; Jane logs on to her bank s website, goes through a loan application, and within a few minutes, she is approved. The process is easy to understand and she can chat with a customer service agent with the click of a button. After logging in to her bank, she was actually redirected to a bank branded version of platform X s website. Platform X provides all the technology for the Bank to support this customer-friendly lending process in a seamless way. The bank has found a partner with the platform and only pays a fee-per-loan, minimizing its up-front investment. PwC 5

7 Joint product development Credit modeling process Servicing and collections Joint product development between banks and marketplace lending platforms could take many forms, depending on the needs and strengths of each partner. It might involve developing credit products that a marketplace lender might not typically offer but meet the specific needs of a bank. One current example of this is a platform that has an agreement with a large national bank to originate and sell to the bank loans that fulfill required CRA goals. Another possibility for partnerships is collaborating on new credit models, where banks and MPLs use their diverse assets including alternative data, bank proprietary data, and traditional credit bureau data to develop advanced credit models. Imagine: Regional Bank has a long history of always being there to meet its customers financial needs. It offers a wide variety of products and has collected extensive financial and transactional data on its customers over decades of relationships. Yet, it is finding that some of its younger customers don t use many banking products and don t have very long credit histories. Regional Bank wants to ensure that it can continue to meet these customers borrowing needs, but feels it doesn t have all the data to make informed, risk-based decisions. Regional Bank decides to partner up with Platform Y to create a credit scoring model that combines Regional Bank s wealth of customer relationship data with Platform Y s social and other non-traditional data and expertise to make effective credit decisions. Both companies are able to leverage each other s strengths and assets to advance their own business needs. PwC 6

8 Identifying a strategic partner Partnerships to provide capital or purchase loans require banks to have a good understanding of marketplace lenders credit standards, underwriting processes, and compliance and quality controls. Yet strategic partnerships require even more up-front investment, have a longer time horizon, and have a lasting impact on overall product, customer, and revenue potential for both partners. There are a variety of reasons why a bank or traditional lender may want to partner with one of the marketplace lending platforms, and based on those goals they may look for partners where there is already an alignment, or conversely, they may look for a partner with complementary features. By identifying the categories to consider, lenders can effectively outline their goals for a strategic partnership and then identify possible partner companies. Once goals for the partnership are clearly established and possible target companies identified, it is time to take a closer look at the target companies to assess internal factors that could point to a good match. These factors include compliance rigor, operational efficiency, risk management discipline, culture, credit risk appetite, and reputation, just to name a few. Banks must carefully vet any third party for compliance with all applicable laws and regulations, overall customer service, operating model, and rigor around risk discipline. Each entity must also be mindful of the proper transfer and safeguard of customer data, particularly in light of the increase in cyber attacks. By ensuring that the marketplace lending partner has the appropriate processes and controls in place, banks can gain comfort that the partnership will provide longterm accretive benefits. Considerations such as operational efficiency and technology scalability will be indicators of a platform s ability to grow and succeed beyond the startup stage. With the high-volume, smaller dollar nature of many marketplace loans, manual tasks and operational inefficiencies will be magnified as platforms begin to grow. Any technology deployed must be able to quickly scale to handle large volumes, and operations should be streamlined and automated as much as possible. PwC 7

9 Evaluating potential partners The framework below provides a guide to banks and other financial firms to help them assess potential marketplace lending partners. It also serves as a guide to marketplace lending platforms that are looking at strategic relationships with a banks, to help them prepare for due diligence. Key CMS elements include: The due diligence of potential platform partners should be holistic and detailed and include elements such as company history, operational competency, technology, financial stability, credit risk management and enterprise risk management, compliance management and quality control programs, and servicing and collection practices. Each element should be thoroughly assessed and evaluated; this may be performed by a third party, and it likely will involve a series of data analysis, documentation review, and on-site meetings with management to delve into areas of question or concern. With respect to bank-marketplace lender partnerships, regulatory compliance is an area of specific focus. An effective Compliance Management System (CMS) will establish the framework for identifying, assessing, controlling, monitoring and reporting compliance risks across the platform. It will also give a bank partner confidence in the platform s ability to manage key compliance risks. PwC 8

10 An effective CMS is the foundation for any organization to succeed at risk management; however, there are a number of additional considerations specific to partnerships between banks and marketplace lenders. Initial partnership due diligence should also include financial due diligence, including a requirement for audited financial statements that demonstrate financial stability, as well as the ability to meet obligations and continue growth. Additionally, banks may require a detailed understanding of the credit policy, underwriting process, and fraud prevention mechanisms, along with its credit model, including actual loan performance history and stress testing under various economic scenarios. Platforms should be prepared to provide potential bank partners with access to transparent and detailed reporting and data feeds that allow insight into portfolio performance, referral performance, or other data related to the subject of the partnership. Regardless of whether data is provided directly or through an intermediary, the platform and the bank should have technology in place that allows both potential partners to efficiently communicate and receive information, in order to maximize customer service, sales opportunities, and risk management capabilities. This reporting and data sharing should be coupled with ongoing performance and risk monitoring to maintain regulatory compliance and to ensure that the expected return on investment is realized. This may include tracking agreed-upon key performance and risk indicators as well as adherence to service-level agreements. PwC 9

11 How PwC can help The opportunities posed by partnerships between marketplace lenders and banks are significant, however integrating the business relationships strategically is the key to success. With our deep banking and consumer lending knowledge and experience with marketplace lending activities, we can assist in preparing for such a partnership, from conducting market assessments to evaluating various partnership strategies or conducting due diligence and advising on regulatory compliance matters. Regardless of whether your organization chooses to partner with a bank or marketplace lender, we can provide advice and support on the critical decisions and key implementation activities that will shape your strategy and help position the partnership for success. PwC 10

12 To discuss a range of services tailored to your organization s needs, please contact: Roberto Hernandez Principal Consumer Finance Group Telephone Linkedin roberto.g.hernandez@pwc.com in/robertohernandez1 Will marketplace lending be ready for increased regulatory scrutiny? Jason Chan Senior Manager Consumer Finance Group Telephone Linkedin jason.chan@pwc.com in/jchan14 Peer pressure: How peer-topeer lending platforms are transforming the consumer lending industry Is it time for consumer lending to go social? Mackenzie Sullivan Manager Consumer Finance Group Telephone Linkedin mackenzie.sullivan@pwc.com ullivan1 Follow us on 2015 PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details.