The lending industry is rapidly shifting from a model with a focus on user acquisition and volume to one that focuses more on unit economics and value. Market pressures, regulatory shifts, and emerging technologies are driving strategies for sustainable growth toward efficiency in underwriting. Here is a closer look at what is pushing the industry away from a narrow focus on scale and its implications for your operation.
Market Pressure Is Forcing Profit Discipline
A major driver on this front is higher interest rates. While the period of hikes appears to have halted, there hasn’t been a return to the era of cheap lending and challenges to the zero lower bound (ZLB) that emerged in the first decade of the 21st century. Capital requirements are tightening, and this creates an environment that rewards companies that emphasize operational efficiency. Stress tests and other forms of regulatory oversight have become more important, especially in the aftermath of collapses involving institutions like Silicon Valley Bank, Signature Bank, First Republic Bank, and Credit Suisse.
Unsurprisingly, investors have shifted their growth focus toward companies that mitigate risks while sustaining growth. For banks and similar institutions, this has meant a move toward data-driven lending. Other solutions have included regional bank consolidation and increased partnerships among smaller lenders.
Customer Quality Matters More Than Customer Quantity
In this environment, the main growth area has been targeting high-quality customers rather than obtaining as many accounts as possible. This has several desirable benefits, including:
- Lower customer acquisition costs
- Improved retention
- Better repayment performance
- Superior per-customer lifetime value (LTV)
Notably, the environment encourages lenders to focus on filtering criteria as they negotiate with customers in subprime segments. While this doesn’t exclude first-time customers or individuals with previously bad credit, it does mean using technology to find the lowest-risk parties within the group. The net effect has been that credit thresholds are rising across all groups, subprime or otherwise.
Established customers are also increasingly valuable. Nonbank operations have been fighting for entry-level and subprime customers, making traditional lenders focus more on established customers who have good LTV ratings. Retaining these customers with favorable lending offers has become a growth driver, and the metrics for this portfolio matter more in investor discussions.
Right now is the time to favor customers that maintain:
- Prime (660+) and near-prime (620-650) credit ratings
- Stable incomes
- Low debt-to-income ratios
- Consistent payment histories and low delinquency rates
- Minimal fraud and compliance risks
These are all highly quantifiable traits that suit data-driven lending well. Another trait to look for in the data of your high-LTV customers is a penchant for using multiple products. Cross-selling offers opportunities to improve profits and customer satisfaction at the same time, and deep data analysis can reveal which customers are the best candidates.
A good data-driven system can also track and reward customers who expand credit lines, upgrade products, and have higher purchase values. You can also see who is regularly referring new customers to your business. Likewise, you can quickly determine the quality of the new business originating from those referrals.
Efficiency Is the New Growth Strategy
Digital lending solutions now account for 74.6% of market share as of 2024. Making this segment especially appealing is the rise of AI-driven risk assessment tools. Not only does this reduce manual processing costs, but it also allows human reviewers to spend more time looking at high-quality customers and less time ruling out parties that were never going to get a loan. Automated decision-making has improved speed and accuracy, and it has also allowed lenders to identify better customers in the riskier market segments. On balance, this has led to a reduction in per-unit risk while maximizing yields.
Improved regulatory technology also aids efficiency. Data analysis can help you flag risks in real time. You can also more easily automate compliance monitoring and reduce related risks. Real-time income verification can also minimize your risk exposure when onboarding new customers.
Capital Markets Reward Profit Over Pure Origination Volume
Old-school value investing metrics are staging a major comeback. Out are the scale-oriented metrics like revenue growth and price-to-sales ratios. In are metrics like earnings before interest, taxes, depreciation, and amortization (EBITDA) and price-to-earnings (P/E) ratios. Many institutions want to see at least $3 of LTV for every dollar spent on customer acquisition costs. Emerging technologies are lowering customer acquisition cost (CAC), too, expanding the base of high-LTV customers, respectively.
Investors are pivoting toward dividend sustainability in the current environment. Credit quality metrics now appear as much in analysts’ notes as growth measures used to because quality and consistency power dividend payments in tough environments.
Resilience and Regulation Favor Smart Growth
Even with a tighter regulatory environment and greater macro uncertainty, growth orientation is far from dead. Instead, the focus is on how to grow sustainably in a tougher lending world.
Resilience is essential. Companies need to care more about:
- Capital requirements
- Projecting forward-looking loss estimates
- Stress testing amid high macro volatility
- Risk management frameworks that factor in growing cyber risks
- Buffers for counter-cyclical events and downturns
Growth can be particularly challenging when companies are more wary of high-growth segments. While diversification is historically good, these segments can introduce heightened volatility at a time when lenders can least afford it. Data-driven lending offers the best way to filter for the lowest risks in these challenging but potentially highly profitable segments. This ensures that your portfolio captures growth without extending your risk profile.
Growth, Profit, and Scale in the Near Future
The most optimistic prevailing expectation is that the interest rate environment is unlikely to revert to the Fed’s historical 2% target before the end of 2026. Data and technology offer lenders the means to scale long-term and profitably in the meantime without taking on risk. With the right strategy, you can incorporate these new approaches to position your lending operations well regardless of what the future holds.