[Editor’s note: This is a blog post from Gavin Harding, senior business consultant at Experian. Experian is a Gold Sponsor at LendIt USA 2017 which will take place on March 6-7, 2017 in New York City.]
Though he wasn’t referring to the state of the online marketplace lending industry, legendary singer Bob Dylan summed it up best in his lyrics – “the times they are a-changin.” Following what could be generously described as a bumpy year for the industry, marketplace lenders face a challenging road ahead as they seek to restore trust and credibility with consumers, banking partners and investors alike.
No longer simply satisfied with top-line revenue growth, the investment and banking communities are now viewing the industry more pragmatically, taking a “show me, don’t tell me” approach when it comes to representations of business practices and results. Rebuilding the trust and confidence that has been lost will require a foundation of transparency and consistency, and a more strategic approach to data and model governance.
Rebuilding Credibility: The Importance of External Validation
Federal and state regulators are now focusing on this burgeoning industry. Lawmakers are working to understand the benefits and risks of online marketplace lending. This has led the industry to explore mechanisms for self-policing. Over the last year, six industry associations were formed to represent the industry and assist in interactions with government, regulators and the public. These associations are leading the charge on self-regulation.
Beyond these associations, marketplace lenders are looking to outside experts to provide independent external reviews and objective validation of policies, as they relate to portfolios and credit models that score and predict performance. Such external benchmarking will go a long way towards reestablishing credibility. It also behooves these lenders to take a proactive approach with regard to explaining their credit models, providing greater transparency into documentation, and adopting more formal methodologies and processes. Potential investors and banking partners want to know there will be a strong internal commitment to transparency as the foundation for longer-term relationships, as opposed to simply taking a transactional approach.
Why Taking a Disciplined Approach Matters
The quality, consistency and reliability of the data used in making lending decisions is critical to the credibility of the business. When reviewing business credit, the data must be independently verifiable, consistent, tested and robust. Truly independent data should be confirmed by multiple sources that triangulate its accuracy. Adherence to these values, which are inherent in a disciplined approach, is absolutely fundamental for marketplace lenders as they look to restore trust.
Risk model governance is another area where marketplace lenders have an opportunity to reassure investors and banking partners. A good approach to ensure the efficacy of models is to employ a consistent, thorough testing and validation process. Effective model governance should include testing on a frequent basis, allowing the models to be refined and updated. It may also incorporate macro and micro economic factors from the broader environment. Thoroughly tested and documented model governance practices demonstrate the discipline that instills confidence in the investors and partners.
It Takes Two to Tango: Matching Skills and Resources
Perhaps the final step on the road to rebuilding trust and confidence is recognizing the importance of matching the needs and resources of marketplace lenders to those of investors and banking partners.
When it comes to working with banks, compatibility is crucial. After all, banks and marketplace lenders are on two different sides of the same business. Banks generally have developed longer-term and deeper relationships with clients, while marketplace lenders are often more transactional. Banks offer scale and access to funds, while marketplace lenders provide speed, agility and can perhaps more readily meet the needs of smaller businesses. Clearly, there are significant opportunities for synergies here that can allow both sides to work together and prosper. It’s just a matter of coordinating those skills and resources properly to gain competitive advantages.
Investors, which may include banks, are an equally important part of the equation. Whether on the debt or equity side, investor due diligence is critical. There is now an expectation that marketplace lenders demonstrate, through objective assessment and review, how strongly committed they are to good governance, transparency, policy, disciplined management and reporting. Showing, rather than telling, will allow investors to know if they’ve found a match worthy of their investment.
As marketplace lenders look to allay investor concerns or consider partnerships with banks, a strategic approach to model and data governance can go a long way to establishing credibility. By identifying gaps and opportunities and implementing sustainable improvements aimed at supporting operational discipline and efficiency, and also providing a benchmark for investors and potential partners, marketplace lenders can earn back the trust that has been lost. And in the face of increasing regulatory scrutiny, proactively addressing policy, process and strategy concerns just makes good business sense. Yes, “the times they are a-changin”, but sometimes change can be a good thing.