[Editor’s note: This is a blog post from Bill Ullman, chief commercial officer at Orchard. Orchard is a Silver Sponsor at LendIt USA 2017 which will take place on March 6-7, 2017 in New York City.]
After nearly a decade of phenomenal growth, 2016 marked the first legitimate rough patch for online lenders. At Orchard, we continue to believe in the promise of fintech and online lending. However, if our young industry is truly going to mature, it should use these difficult moments as an opportunity to learn, strengthen, and move forward. In order to do that it is necessary to make a proper (and honest) diagnosis of the problems. Otherwise, we run the risk of making the same mistakes over and over.
Lessons in the importance of implementing a holistic risk management strategy can be costly, particularly when they’re learned the hard way. Wall Street is engaged in a constant, uphill battle to regain the public’s trust because of a steady stream of lawsuits, negative headlines, and the hefty fines levied against them decade-after-decade. In fact, the events that led up to the last financial crisis (and helped set the stage for the emergence of online lending), one could argue, are directly related to failures in risk management. Unfortunately, risk management is one of those disciplines that often isn’t prioritized, or considered critical, until something happens (particularly at startups, where risk management is often viewed strictly as a cost center that must compete for limited resources with other revenue generating activities), but at that point, it is often too late. Liquidity is another one, but I’ll address that later on. Rather than just a subset of operations, or legal and compliance, and a series of checkboxes to tick, it might be helpful to remind ourselves that the entire financial services industry is an exercise in risk management. For online lending, originators base their lending decisions on the analysis of credit risks associated with a given borrower. Investment managers and advisors weigh the risks of an investment, versus the potential rewards, in light of overall investment objectives and risk tolerances when allocating. Company executives, senior management, and the board of directors make business decisions and set strategy by weighing a variety of risk factors against achieving broader corporate goals. Implementing a holistic risk management strategy is about identifying and analyzing risks in an effort to control and mitigate them across an organization on an ongoing basis, and should become an integral part of company and industry culture.
Data and technology are at the core of fintech. That is why it can be surprising to some, when they begin their evaluation of online lending, to learn that data quality across the industry can be inconsistent, inaccurate, or simply unavailable. For investors attempting to conduct detailed loan analysis across the industry, at best, it is a costly and time-consuming endeavor, requiring expertise and dedicated resources able to dig in and understand the reporting subtleties of multiple loan originators and to develop systems and processes that standardize the data on a continuous basis. At worst, it is a hurdle that is too high for them to overcome. Combine very public disclosures of mistakes, improprieties, or other high-profile events calling the veracity of data into question, with concerns about underwriting models and flagging performance, and it becomes increasingly difficult for investment committees to approve investment in this asset type. Focusing on data quality, integrity, and transparency as well as setting a higher standard to promote best practices and increase confidence in our industry should be an ongoing priority.
An efficient, diversified method of selling and reselling loans is critical to the industry’s growth and longevity over multiple credit cycles. While certain specialized institutional investors have entered the space and securitizations are at record highs for online lending (particularly in student lending), these are a tiny fraction of the addressable market. Improved liquidity would, among other things, support the creation of investment vehicles like ETFs and mutual funds with low fees and investment minimums that appeal to mainstream investors and advisors. Total U.S. retirement assets were $25.0 trillion as of September 30, 2016, according to the Investment Company Institute and even a small portion of that represents a relatively large and untapped source of funding for lenders seeking to diversify their funding models. Additionally, the last financial crisis taught a pointed lesson in market liquidity risk, and for balance sheet lenders and more traditional financial institutions such as banks, liquidity risk management should be top of mind. During times of market stress, or when negative headlines put pressure on businesses, liquidity will likely be the difference between success and failure for non-bank, balance sheet lenders without access to deposits, the Federal Reserve System, or alternate sources of funding.
It can be difficult to remember that online lending is still in the early stages. For all the successes—for example, completely transforming the loan application process, a process that hadn’t changed much in hundreds of years—there have also been mistakes. There have already been a number encouraging announcements since the beginning of the year and signs that online lending businesses are getting back on track. By renewing our commitment to providing unprecedented transparency and quality in data and operations while holding ourselves to the highest standards of risk management, 2017 may be looked back on as the year when the leaders and brand names of the future were established.