Lending is one of the oldest businesses in the world. Sometimes, however, even an old dog must learn new tricks—especially when customers expect more and have more choices. How will lending institutions respond to the cataclysmic digital shift that is taking place in the world of finance?

By digital shift, we mean the transformation businesses will undergo in their processes, services, and operations. These transformations will respond to the rapidly accelerating technological developments impacting every sector of the economy, including financial services such as lending institutions.

Challenges Of Digital Transformation For Lending Institutions

First, the bad news, so we can end on a good note. There are pros and cons lending institutions must face as they join the digital shift.

Security And Privacy

One obvious concern is not a new one: security and privacy. These have been concerns in the financial services sector for ages. However, the acceleration of new technology within the past several decades has increased the importance of these particular challenges.

Take a loan application, for instance. Someone with a stolen social, who has done some research on Facebook, can easily get a credit card, even an unsecured personal loan, or an installment loan in someone else’s name. However, there are steps your organization can take to thwart this kind of identity theft.

A simple one is 2FA or two-factor authentication. Suppose a customer is filling out their application for a loan (personal loan, auto loan, student loan, home equity loan, or credit card). A code is texted to their phone number before their credit check (let alone loan approval). If the person is truly in front of their phone, they can input the code.

This is just one simple example of policies and procedures lenders need to implement to improve the security of their processes. 

Regulatory Compliance For Lending Institutions

Regulatory compliance is another evergreen issue lending institutions face. Arguably, the severity of this issue changes based on the current executive administration. Either way, lenders must adhere to regulatory requirements or face steep fines and penalties.

One of the most far-reaching codes is the Truth in Lending Act, or Regulation Z. This legislation protects consumers from unfair or deceptive lending practices. Reg Z is an extremely detailed set of laws that even dictates rate and terms details, like stating percentages to the second decimal point during sales pitches and whether there are any prepayment penalties.

New digital processes will complicate the already extant regulatory landscape. For instance, some pundits have described the intersection of big tech (Apple, Google, Facebook) and financial services as one of the biggest regulatory puzzles of our times.

How will lawmakers respond to the rapidly expanding advent of Supertech (like payment terminals that conduct biometric scans)? How will they respond to the massive snowballing of customer data? And how will these policies shape and/or limit the digital interactions that lenders have with their (potential or current) customers during the life of their loans, before or after their services?

Fintech Startup Competition

Mobile applications have evened the playing field for many tech startups, a trend that will likely be increased by the low-code or no-code offerings of AI language models (e.g., ChatGTP or Google’s Gemini). Traditional lenders are facing lots of app-based competition.

Some apps will provide consumers with a cash advance without any credit survey. How can a bank’s lender offer compete with that if they must turn the customer away for a credit card or a non-collateral loan? This customer will just take their business to one of these other apps.

There are online banks that offer a higher interest rate (5% APY) on checking accounts, a feat that brick-and-mortar banks cannot replicate due to their overhead. Apps are offering never-before-seen, innovative solutions.

For instance, some apps will provide subscribers with a credit line to combine loans such as credit cards and car loans into one line to reduce their utilization ratio. There is no risk to the company because the customer cannot use the credit line; it’s only there to reduce their ratio.

Banks will have to develop engaging, innovative solutions if they want to keep up with exciting startup innovations in the blossoming fintech space.

Complicated Legacy Systems

The average customer is probably unaware of just how old some banking systems are. These legacy systems may have limited functionality and/or be susceptible to cyber threats. Banks and lending institutions will eventually have to shift out of these legacy systems, which is a massive data migration project.

Consulting firms like Deloitte have acknowledged that it is becoming increasingly more difficult to maintain these systems as the pool of experts familiar with them dwindles down. The exodus of talent into retirement is a serious concern that could expose legacy systems to danger and need maintenance.

This means that banks and lending institutions will need to migrate their data and systems to “the cloud.” That is an expensive and time-consuming proposal, but one that is probably unavoidable. Business continuity in the face of potential disruptions during this shift will be important for maintaining the integrity of customer experience. 

Benefits and Improvements For Digital Transformation On Lending Institutions

And now, onto the benefits. Consumers can check their credit score or apply for a line of credit or HELOC right from their phone. Let’s take a look at these exciting developments. 

Insight Harvesting

One great benefit of the digital shift is the increased availability of data. The harvesting and analysis of this data are reaching unprecedented heights.

For instance, banks that also offer home equity lines of credit can analyze a customer’s debit card transactions. Perhaps this customer shops at Home Depot a lot. It’s time to start suggesting a HELOC to this customer on the homepage of their banking app.

Banks have always been interested in “deepening customer relationships,” so much so that Wells Fargo got their hands caught in the cookie jar, opening up fake bank accounts. In times past, banks would attempt to probe the waters of potential product sales through conversations.

Now, big data can do all that work. The bottom line is that lending institutions can cross-sell customers different loan types. Financial partners can also easily discover opportunities to present a customer with a certain product.

Increased Efficiency

Another benefit of digital transformation for lending institutions is an increase in efficiency. A bank or lender’s business day is filled with processes that can now be entirely or partially automated. Customer onboarding, fraud detection, customer support, and assessing loan eligibility can all be streamlined through digital transformation.

Take customer support, for instance. Rather than have a large team of phone agents ready to answer questions (what’s my interest rate, what’s my loan payment, can I refinance this loan), chatbot support can deliver immediate answers to the inquiring customer. Then, if the customer is in need of further support, the chatbot can connect them with a live agent.

Of course, you must assess the balance between efficiency and customer experience. If the process of delivering information to customers is not smooth, you risk upsetting them. However, if you can perfect chatbot support (as one example), you can reduce the need for customer support and save a significant amount of money.

Machine Learning And AI

One of the costliest and most time-consuming parts of lending is underwriting. However, that is about to change with the digital changes sweeping financial services. 85% of banks worldwide are using AI to some degree to automate loan management, but not all of that is involved with credit analysis.

In fact, a surprisingly low 8% of small banks (and 32% of big banks) are using AI for origination and credit analysis. This represents a huge opportunity in the fintech space for both unsecured loans (like credit cards) and secured loans (like mortgages).

It will be interesting to see over time if using AI to help borrowers apply for loans will reduce the number of loan defaults. In this way, AI becomes a frontline of defense that protects lenders from bad debt.

Streamlined Experiences

Another exciting aspect of the digital shift is customer experience. From a customer dashboard, borrowers can quickly glance at their annual percentage rate (APR) and FICO score. 

These tools for monitoring their credit profile can be accompanied by more detailed possibilities to examine loan terms or see the long-term prognosis of loan repayment based on their current monthly payments.

Banks are invested in enriching their consumer-facing applications with budgeting breakdowns and instructional content on how certain choices affect your credit score. On the origination side, customers can play with loan calculators or browse through the best options for debt consolidation.

Today’s customers appreciate transparency. They may not want to know every detail of the loan agreement, but they do want to know about lender charges like late fees. They want a streamlined experience they can access 25/7 right from their phones. This transparency and accessibility are made possible through the app-based digitization of consumer-facing lenders.

Digital Transformation Of Lending Institutions Wrap-Up

Digitization is an exciting trend in any industry, but in fintech, it is particularly promising. Established banks and their legacy systems will have to run to catch up with the tens of thousands of fintech startups around the world. The challenges and rewards of this digital shift will continue to shape how lenders interact with their borrowers.

Frequently Asked Questions About The Digital Transformation of Lending Institutions 

How is the digital world transforming lending institutions?

With the advancement of technology, lenders are now experiencing the innovation of online loan applications, mobile banking apps, chatbot support, and AI-powered underwriting, which helps not only streamline their business operations but enhances the overall customer experience. This makes the financing process much simpler for the lender and the borrower. 

What are the benefits lending institutions can take advantage of with digital transformation?

The transformation of digital technology can help provide lenders with machine learning and AI tools, insightful analytics, increased efficiency, and an overall streamlined experience for both the institution and the borrower.

What are some challenges lending institutions face with digital transformation?

Though technological advancements can be leveraged to improve the business experience, they are often accompanied by challenges like security and privacy concerns, regulatory compliance requirements, increased competition, and complications of using legacy systems.

How can lending institutions overcome digital transformation challenges?

To overcome the challenges that digital transformation poses, lending institutions should invest in advanced security measures, stay up-to-date on regulatory compliance, migrate data to the cloud, and consider partnering with fintech companies.