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FinTechs vs. Traditional Lenders – Is There a Difference?

TransUnion recently released a study comparing FinTechs to other lenders, and used personal loans issued between 2014 and 2016 as the basis for the study.  The study’s objective is to answer the question, “Are FinTechs different from other lenders?”  Interestingly enough, this is a question credit unions have been speculating on for years in an effort to understand the new type of competition FinTechs are bringing to the industry and how to respond.

While the study contains a wealth of fascinating information, we are going to focus on two areas in this blog.  The first is age distribution of consumers by lender type.  Often, credit unions believe that FinTechs are more popular in the younger age demographics, as those age groups are likely more tech savvy and willing to bank in non-traditional ways – two of the main value propositions of FinTechs.

Surprisingly, the following graph indicates that credit unions do better in attracting the younger demographics than any of the lender types – including FinTechs.  Where FinTechs shine is in the 30-64 age range, which is when most consumers are borrowing.

Table:  Age Distribution of Consumers by Lender Type

Graph showing age distribution of consumers by lender type in FinTechs study

This raises a number of questions for credit unions, some of which are:

  • Why are credit unions attracting more 18-29 year olds?
  • What sort of business are credit unions receiving from this group?
  • Is the competition for the younger age demographic detracting from competing in the age demographics where consumers do most of their borrowing?
  • If FinTechs often compete with traditional lenders on technology and non-traditional banking, why are they more successful with the 30-64 group compared to credit unions than the <30 age demographic?

Some of the answers may challenge credit unions, given the strategic focus and discussions about how to increase Millennial membership in recent years.

The second area of the study is on credit risk.  There is often a question about how much credit risk FinTechs are willing to take, with the speculation that they are generally taking riskier loans.  According to the study, the FinTechs’ approach to credit risk is more nuanced.

The chart below show that FinTechs are generally willing to lend more money to consumers.  This does lead to more credit risk exposure, given the higher loan amount.

Table: Average New Loan Amount

Graph showing average new loan amount in FinTechs study

However, when looking at the distribution of originations by credit score, FinTechs’ credit risk is right in line with credit unions.

Table: Risk Distribution of Originations

Graph showing risk distribution of origination at t in FinTechs study

In combination, these two charts suggest that while FinTechs are willing to lend more money, they are not focused only on the near prime and lower credit scores.  This again may challenge credit unions’ view as it suggests competition from FinTechs is not isolated in the lower credit risk tiers and in fact, FinTechs are competing across all credit scores and age ranges.

In light of this information, it would be good for decision-makers to have strategic discussions about how this could impact the credit union and its strategy.  This is a great topic to discuss during a board or ALCO meeting.  Participants can read the study beforehand, and come ready to discuss the impacts – positive and negative – to the credit union, and consider if any changes to the credit union’s strategy need to be discussed.

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Sharing Economy Ripe For Disruption By Blockchain Technology

It turns out that the internet is a great matchmaker—even beyond dating sites.  eBay matches buyers to sellers, Airbnb matches rentals to renters, and LendingClub matches borrowers to lenders.  Now, these stars of the sharing economy, many of whom were disruptors, are ripe for disruption themselves.

A definition of sharing economy

These businesses still have a lot in common with traditional business models.  The platform owner ensures that business is conducted as agreed, provides a level of safety, and takes a (sometimes hefty) cut as profit.  This is where the use of blockchain technology has the potential to foster enormous change.

A definition of block chain technology

Take ridesharing as an example, and imagine drivers and riders connecting directly via an app.  They are negotiating their own transactions without a middleman like Uber or Lyft.  (There are already startups doing this.)  Some view this as a more authentic sharing economy where individuals are not beholden to big corporate entities.  Blockchain makes this possible through its ability to provide things like digital identities linked to a publicly available reputation system and cryptocurrency payments—with no intermediary.

While the financial services industry has so far survived the “LendingClubs” of the world, the emergence of blockchain could change the game for better or worse.  Blockchains don’t have to be public.  There is a lot of investment and development underway on permissioned blockchains that can be utilized privately by a financial institution.  These could be used to make the infrastructure far less expensive, create efficient and secure ways to automate contractual agreements, track financial transactions, log asset ownership, etc.

And for once, regulation might be a good thing.  The highly regulated nature of the industry makes it more complicated, time-consuming and expensive for new entrants to carve out niches in this space, especially using new underlying technology.

These are just a few examples of how blockchain could disrupt the sharing economy and financial services.  The possibilities are endless.  It’s like going back to the 1990s and asking what we would be able to do with the internet—even though most of the answers hadn’t even been thought of yet.

*Definitions sourced from Oxford Dictionaries.

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Elevate Your Budgeting Process

The following article was written by c. myers and originally published by CUES on November 20, 2017.

The credit union budgeting processMore and more financial institutions are recognizing the value of elevating budgeting to expand strategic thinking and drive better business decisions.  The strategic budgeting process is an ideal avenue for connecting strategy, desired financial performance and risk appetite.

To do budgeting well, an organization needs to build its base financial case on a solid foundation—and then consider that budget in strategic ways.

As an example, many financial institutions have invested heavily in technology over the past few years, and a number of them are continuing to do so.  It is important that the strategic reasons for those investments are represented in the financial forecasts.  Perhaps there is an initiative to make it easier to do business with the credit union, and part of that initiative involves technology investments intended to increase loan volumes.  Is the budget showing the expected boost in loan balances and income?

Executives are also recognizing that the time between making an initial investment and reaping the benefits—such as funding more loans or making systems and processes more efficient for employees—can be measured in years rather than months.  It is important for boards to understand the expected timing of the benefits along with the expected financial results of the initial cost.  To accommodate this, the budgeting forecast period is being expanded by many organizations to at least three years and, in many cases, five years.

A detailed budget for year 1 combined with a longer-term forecast is designed to provide a high-level directional view, not to be exactly “right” for years 2-5.  It’s hard enough to be right for one year!

It’s worthy to note that the answers to some of your strategic budgeting questions may not be obvious by looking at the budget, so you may have to ask senior management.  What’s important is that you ask those relevant strategic questions.

One of the greatest values for the board is in the discussion with senior management and gaining more clarity on what the team is doing in the short term to drive toward the longer-term strategic goals set by the board.  This can help with the order of priorities and speed of implementation at both the strategic and operational levels.

Key Questions

Here are just a few questions to consider as you elevate your budgeting process:

  1. How is our strategy reflected in the budget and forecast?
  2. To link our credit union’s strategy with desired financial performance, how far out does our credit union need to forecast?
  3. As things become more complex, should the board ask for a range of likely financial performance versus committing to one set of financial outcomes?
  4. What key forces could upset our forecast?
  5. How does the budget and forecast align with our appetite for risk?
  6. Each credit union faces unique issues.  What other key internal and external headwinds and tailwinds are we facing that should be reflected in our budget and forecast?

A very important piece of the strategic budget is the documentation of rationale for the most important assumptions, especially those that drive results, and how those assumptions relate to strategic initiatives.  If higher lending volumes are assumed in the budget as a result of new technology, that should be noted.  If lower deposit growth is projected due to the economic forecast, that should be noted as well.  Good documentation will make it much easier to answer questions that are sure to come up later.

It is critical that leaders have a clear-eyed view of how strategy and the forces affecting it can impact their financial performance.  This view could result in changes to the order and speed with which priorities are implemented.  But, it’s far better to adjust for what is seen through the windshield than to react once it’s in the rearview mirror.

c. myers corporation, Phoenix, has partnered with credit unions since 1991.  The company’s philosophy is based on helping clients ask the right, and often tough, questions in order to create a solid foundation that links strategy and desired financial performance.

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Optimize Your Budget Business Intelligence

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Given all of the time and rigor that typically go into the annual budget process, it makes sense to consider how that process might be improved and generate greater business intelligence for decision-makers.  Beyond creating a base budget, following these 6 steps can help take the budgeting process to the next level and provide leaders a significantly better understanding of potential outcomes.

Diagram showing steps for optimizing your budget business intelligence

1)  Begin with the Baseline Budget
The baseline budget should provide a solid foundation for understanding how the primary strategy is likely to impact financial results.  Building upon the credit union’s strategic directions, the budget assesses the impacts of expected new business goals, deposit generation, investment strategies, non-interest income, and operating expenses.  The budget establishes the fundamental expectations for the core strategy and how it will impact the financial measures for success such as return on assets (ROA) and net worth ratio.

2)  Use a Long-term View
Looking beyond the next fiscal year acknowledges that the budget is not a destination, but a path to the future.  It can be useful to see the longer trending impacts of decisions made today, even while recognizing that uncertainty increases when projecting further into the future.  Our clients tell us they find long-term financial forecasts showing impacts over the coming 3-5 years provide valuable information and an early warning while not wading too far into the uncertain future.

3)  Understand the Impacts of Changing Rate Environments
Asset/liability management (A/LM) should be an integral part of the budgeting process.  After understanding the baseline budget, assess the sensitivity of the budget to interest rate risk (IRR).

This process begins with choosing the market rate assumptions in the baseline budget.  We recommend credit unions develop baseline budgets assuming market rates remain at current levels.  By so doing, the impacts of the strategic assumptions can be isolated from the potential benefit or detriment of changing market rates.  Otherwise, the market rate changes may hide risks and opportunities driven by the core strategic assumptions.

Once the baseline budget impacts are understood in the current rate environment, play through a variety of likely and potential market rate changes, with rates increasing and decreasing, and where short- and long-term market rates move independently (i.e., twisted yield curves).  How sensitive is the structure to those changes in rates?  And what other decisions might be made today that remain consistent with the overall strategy but may reduce potential net income volatility in changing rate environments?

4)  How is the Credit Union Positioned for IRR if the Budget is Successful?
Regardless of how far forecasts look into the future, targets are typically established for the coming fiscal year for measures such as growth in members/assets/deposits, ROA, net worth, etc.  While assessing the impact of changing rate environments along the way, how well-positioned is the credit union for future IRR in 1 or 2 years if the budget is achieved?

Using the target financial structure implied by the budget, how would the A/LM modeling assess IRR at that point in the future?  Is the credit union better prepared for market rate volatility, or did the credit union increase its risks?  Are IRR policy limits and guidelines still being met?  If not, understanding those risks today and weighing options with the board and management could be critical.

5)  Consider Alternative Scenarios beyond the Base Budget
Most would agree that having a clear picture of the future would be a welcome gift, especially during budget season.  Unfortunately, predicting that future can be a tricky business.  Instead, we often look to recent trends to inform us of likely market directions and pressures.

When trends appear likely to impact the credit union’s business model or strategy, it can be valuable to consider the extent of those impacts and likely responses the credit union may take.  Ask how trends might impact the business model, and develop what-if scenarios to understand the potential financial implications while also testing mitigating strategies.

For example, what if the trend data suggested mortgage volumes may slow, and a growing opportunity for more home equity loans?  What challenges or opportunities might that present?  Similarly, what if some regulators warned about the risks of low-cost funding sources going away, and at a time when long-term assets in the industry have been increasing?  What if funding costs increased more rapidly than anticipated?  If concerns exist for the credit union with regard to long-term assets, what options might exist today (i.e., before more of the industry might face similar pressures) to mitigate the risk in some way?

Considering alternative scenarios can better prepare management and boards for potential impacts, and create more informed strategic dialogues.  Modeling such scenarios early can better prepare the credit union to pivot from current strategies should those trends continue by creating awareness and understanding.

6)  Effectively Summarize the Results
The value and power of this additional business intelligence can be lost if buried in an array of detailed reports.  However, by being clear on the critical measures to evaluate, we have found that the results can be typically summarized in a 1- or 2-page document.  Using a brief description of the budget and what-if options, the measures can be included in table form.  This allows decision-makers to quickly assess the different outcomes of each of the various options and how they compare.

For many credit unions, the investment in the annual budget is significant.  Perhaps because the effort can be monumental, many do not focus on generating the additional value that can come from these steps.  However, with the powerful tools available to credit unions today in budgeting and A/LM software, steps 2-6 should require a fraction of the typical budgeting time while delivering exponentially greater business intelligence to decision-makers.  Tools today can allow for fast-paced what-if scenarios, building on and creating more value from the baseline budget.  Using these tools, credit unions can do more to rehearse many possible tomorrows today.

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Driverless Car Innovation Drives Impact on Financial Services Industry

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It’s not too soon to start thinking about the possible strategic implications of driverless cars and driverless car technology on the financial services industry. Billions of dollars are being invested by numerous companies and sectors to propel the use of driverless technology.

Self-driving or driverless car technology has an impact on the financial services industry.

The impacts can be far reaching. To leverage possible opportunities requires advanced critical and strategic thinking. We thought the article 24 Industries Other Than Auto That Driverless Cars Could Turn Upside Down, by CB Insights, would help jump-start your critical thinking.

Remember, all advancements come with tremendous opportunities. Your job is to find and leverage them!

Read more about the mix of technology and the credit union industry in our blog archive.