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The World of Credit: where the market is heading and Why

Credit as a system existed in Assyria, Babylon, and Ancient Egypt. 3000 years ago, there were borrowers and lenders. A debtor who failed to repay their credit on time became a slave. Initially, credit was primarily related to the history of products, such as borrowing grain. Later, it evolved into financial credit, covering not only consumer needs but also financing trade.

Credit, as we know it today, emerged during the industrial revolution with the establishment of full-fledged commercial banks. The rapid development of production and trade contributed to this.

Credit is the main banking product through which banks generate profit. The more loans  bank can issue, the greater its earnings. Therefore, banks are now focused on digitalization and reducing the time for credit approval to a matter of minutes. While it used to take 20 days to hear a "yes" for a loan, now it can be as quick as 10 minutes. For banks, such transformations contribute to revenue growth and savings, while for borrowers, it provides the opportunity to access funds more quickly. This is especially important for small and medium-sized businesses, as they can almost instantly put the funds into circulation.

Digitalization is becoming the norm, and we are already living in a time where obtaining a loan or buying a refrigerator on credit can be done with just a few clicks on a mobile phone. The most challenging aspects of digitizing are mortgage and auto lending. There are regulatory restrictions, but banks can offer such options even with them. For example, Freedom Bank provides a solution for mortgage loans in just one minute, thanks to underwriting automation.

Many banks have focused on providing a comprehensive representation of the customer journey and their experience. For example, Benelux Banks (the intergovernmental economic union of Belgium, the Netherlands, and Luxembourg) completely reevaluated and changed the lending processes from start to finish, resulting in a 30% increase in profits.

Transitioning to digital processes and products allows for a reduction in operational expenditures (OpEx) and capital expenditures (CapEx) in the lending interest rate calculation, balancing between the final rate for the client and the transfer rate (the interest rate for resource reallocation within the bank).

However, what digitalization cannot replace is personal communication, which is why the quality of customer relationship managers remains important. This is especially true when it comes to lending to small and medium-sized enterprises (SMEs). While self-service may be suitable for some segments, lending to SMEs is best done through the use of an application together with a manager who can guide, explain results, and quickly respond to additional questions.

What else will banks focus on? Risk management will be important in terms of personalized targeting without averaging the risk matrix across the entire portfolio. Additionally, managing acquisition costs, which will allow for the growth of organic traffic from paying customers, will be crucial.

Currently, the borrower assessment process has shifted from focusing solely on creditworthiness to also considering creditworthiness. This is an important aspect in terms of customer evaluation, and based on this data, machine learning (ML) will predictively provide better solutions, improving their overall quality. Working with big data will always prevail over the knowledge and experience of a single officer or committee. All scoring pipelines are already being replenished and will further enrich themselves through government and private databases.

When it comes to major credit products such as auto loans and mortgages, the digitalization of government systems plays a significant role. It is believed that people with similar habits tend to handle finances in similar ways. Therefore, it makes sense to compare potential borrowers with people who have already taken out similar loans. Scoring models are built on this principle. Each company independently determines which parameters are more important to them and what conclusions they need to draw.

Furthermore, Chat GPT demonstrates that AI will be a new milestone in many industries. Banks will also explore the possibilities of AI to make more informed and precise decisions, allowing them to evaluate loan applications based on multiple factors simultaneously. However, more about this is yet to be discovered in the next 2-3 years.

The global market sets its own rules for the coming year. High base interest rates and inflation-fighting tools are leading to a reduction in lending volumes. Financial organizations are choosing financing instruments without credit risk, as their market yield provides sufficient profit with minimal risks and losses. 2023 will also be a time of steady growth in the base interest rate or its maintenance at a certain unchanged level. Reducing inflation is a top priority for central banks compared to possible economic stagnation.

On the other hand, customers dictate their own rules as well, as they want to allocate resources more rationally and save. Therefore, banks need to introduce new products that provide win-win solutions from all sides.

Many banks are betting on several new products that can be expected in the future. For example, family sharing of loans for major purchases, where the product allows customers to distribute the credit burden among all family members. This also includes mortgage sharing.

We should not forget about the development of self-governance at the housing cooperative level, where collective decisions, such as the installation of a playground, are made. In this case, loan payments will be distributed in monthly utility bills. This will also help banks expand their customer base.

Digitalization of point-of-sale (POS) lending is also an important trend. The service of applying for a loan or installment payment is similar to trade acquiring: the tasks of connection, configuration, and management are alike, making them relatively easy to digitize.

Looking at the global market, we can see a movement toward BNPL (Buy Now, Pay Later). It is a form of installment credit where banks allow customers to pay for a product in several installments. This is one of the new products specifically designed for B2B transactions. For them, BNPL serves as an investment tool as companies don't have to pay the full amount upfront, and they can put the "saved money" into circulation. The surge of BNPL in the B2B sector makes it one of the fastest-growing products. It is expected that the global BNPL market will grow by 26% annually from 2022 to 2030.

We should also remember about neobanks, which need to generate profit this year. Creating credit products is possible for them but requires a series of lengthy processes. They need their license, portfolio, willingness to take risks on their balance sheet, funds, capital, and many other things. Of course, it is easier to funnel and work with customer traffic, earning a risk-free margin and increasing the company's capitalization. This year will clarify who will focus on credit products.

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