An economic boom across the globe is expected in 2021 following the mass devastation wreaked by the Covid-19 pandemic. While South Africa’s economic recovery has seen a glimmer of hope in some sectors, SMMEs which the government wants to provide 90% of jobs by 2030, have especially been hit hard, and unemployment is at an all-time high.

McKinsey believes the time is ripe for new entrants to join or disrupt the credit market and offer services to customers where banks and insurers are failing during the Covid-19 pandemic.

South Africans are quickly losing faith in financial institutions such as banks and insurers which have been accused of giving clients the run around and not thinking out the box when servicing them. A reason for SMMEs closing shop or laying-off staff is mostly due to the cumbersome accessing of finance. This, despite money been made available to banks by the state to support businesses during the pandemic.

In South Africa, insurance startups such as Naked Insurance and Pineapple, are just two of the businesses disrupting the market. They have tailor- made packages for individuals, offer instant and fair insurance as well as deals such paying less for your car the less you drive it.

Naked’s tech-heavy approach allowed it to immediately integrate and market a feature allowing clients to pause their coverage. The business reportedly grew more than three times in 2020. International management consulting firm McKinsey & Company says the time is ripe for new entrants to join or disrupt the credit market and offer services to businesses where banks and insurers are failing.

“The global Covid-19 pandemic touched off economic effects that essentially ended the previous credit cycle in most markets. As these markets slowly resume normal activity, a new credit cycle will begin, offering innovative
lenders a rare opportunity to expand into credit markets and win market share,” a McKinsey briefing note reads.

“The resumption of the cycle also offers a window for new entrants such as utilities, insurance companies, and other non-traditional lenders to join the market.”

It says although banks provide financing solutions to a significant share of the global population, large segments are underserved or not served at all as is the case in South Africa. The report says new-to-market lenders can identify the gaps in lending coverage and try bridge them, it reads.

“Many potential customers would like innovative, tailored solutions that are not always cost-efficient for traditional banks. New entrants can design new offerings quickly and are unencumbered by legacy processes or infrastructure.

“They can move from concept to fully developed offering in two or three months, compared with one to two years for incumbents,” Mckinsey says.

Unlike incumbents, these new lenders may not yet have consumer lending operations nor serving consumers with credit history. They also likely lack the appropriate lending infrastructure, credit-risk models, and reference data. While developing these capabilities, they will need to take a structured approach to manage the risks, the document reads.

“New-to-market lenders could include traditional banks expanding market share as well as nonbank financial institutions.

“These lenders will need to actively manage credit-risk decisions and the enabling technology. By doing the advance work required to establish a credit-decision platform, lenders can move quickly while still taking the right level of credit risk,” the note reads.

It says four enablers of credit solutions are essential for a new-entrant strategy.

Utilising data from a wide range of sources

To model credit risk, new lenders need to aggregate data from various sources. McKinsey says some traditional categories of credit behaviour and demographic data are widely available, particularly for established financial
institutions. These include loan information from lenders, deposit data with banks, and point-of-sale transaction data.

Non-financial companies have other internal sources of customer data, such as product usage, interactions with customer-relationship management, call records, email records, customer feedback, and website navigational data.

“Respecting all applicable privacy regulations and guidelines, lenders can seek to employ data from further sources. These include external data from sources such as retailers, telecommunications companies, utility providers, other
banks, and government agencies,” it reads.

It says for certain types of lenders, acquiring data through partnerships should also be explored. It cites a telecommunications company, which launched an unsecured cash-loan product to serve customers lacking access to formal credit. But because it had little credit information available to develop the offering, it turned to its customer-usage data—specifically, data on mobile bill payments.

The data helped it to devise a proxy target variable it could use to train its credit model. When back-tested for model development, the target variable performed in the same way as typical credit-related information would for
banks. From that point, the company was able to extend credit to prepaid customers via a pilot model, which it then refined based on real-world information.

Building the decision engine

Building a decision engine has new entrants at a great advantage over existing lenders with legacy software that they do not want to alter, the brief reads. The new engine can largely be built using advanced analytics, machine
learning, and other tools that capitalise on speed and agility.

It says through machine learning, the new lenders can automate up to 95% of underwriting processes while also making more accurate credit decisions. Also, real-time machine-learning solutions can improve pricing and help firms monitor existing customers and credit lines through smarter early-warning systems.

Creating scalable infrastructure

New-to-market lenders can start by identifying their ambition and perceived advantage in the market and the degree to which their current technology and data availability will support the initiative. They can then plot the correct path.

It says that companies aiming to compete primarily through strong customer relationships might need only basic risk-assessment processes. These companies can buy turnkey solutions from an established solutions provider.
The brief says that at the other end of the spectrum are lenders whose competitive distinctiveness rely on an integrated, tailored solution.

“That can mean designing and building infrastructure from the ground up. Such complex tailored solutions demand significant investment in time and money. This approach may also require hiring talent with specialised skills and capabilities.”

It gives an example of another telecommunications company, with a subscriber base comprising about 80% of its country’s population, partnering with fintech partners to launch a new lending business. The project required designing technology to support the company’s existing data platforms. It trained current employees and hired new talent to run the lending business. The long-term goal is to expand the offerings with new products, build the
scale of the infrastructure to support the broader portfolio, and collaborate with more financial institutions in the region (by selling credit-scoring services, for example).

Monitoring and maintaining models over time

McKinsey says that during the pandemic, lenders became acutely aware that their solutions needed to account for significant disruptions, whether these come in the form of financial crises or environmental shocks.

“Certainly, during the pandemic, data anomalies and disjuncture led to model failures. Developers must consequently design mechanisms within models to anticipate future large disruptions,” it says.

“The goal is to build models that can be proactive rather than reactive, even under rapidly changing conditions. That way, credit solutions will keep pace with the lending environment.”

However, McKinsey says that although banks face enormous pressure from new entrants in financial services, banks do have an edge in resources they can use to rapidly launch their own digital businesses.

“A potential way forward for banks is to disrupt the disruptors. Large banks have the capital, resources, and expertise to turn the tables on new entrants and launch digital attackers of their own in consumer banking, wealth management, payments, and a range of specialist services,” it says in a separate article.

Some banks have already taken up the challenge.

Many are in India where the State Bank of India has launched YONO, which is a mobile banking app used by customers to do all their transactions concerning banking, shopping, lifestyle and investment.

McKinsey says low interest rates, the impacts of customer de-risking, tougher banking regulation in many countries, and other headwinds are forcing banks to rethink their long-term trajectories.

Building a digital business is increasingly been viewed as an effective way for banks to grow across the globe, it says.

By: Amy Musgrave