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Where traditional and tech meet

August 2015

How banks and marketplace lenders can partner up

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Where traditional and tech meet

What is it that would cause today’s consumers to turn to a new company for their borrowing needs? Why are

technology startups taking on some of the largest and most established financial institutions in the world for the job

of allocating capital? These questions speak to the changing cultural and technological landscape that is starting to

impact the financial services industry – from the smallest players to the largest banks.

Not long ago, the question was – what would the traditional lenders’ response be to all of this? Would they compete

or collaborate? Today we see institutions taking both routes, with an increasing number of established lenders

choosing to collaborate with new marketplace lending entrants. This collaboration began in the form of loan

funding agreements, where a bank funds the loans originated by a platform and then sells the loans back to the

platform, along with agreements for banks to invest in marketplace loans, purchasing loans that fit their credit

profile. Today the question becomes: which banks will be the first to truly capitalize on the deeper opportunities

that these partnerships have the ability to open up?

Marketplace lenders are often seen as disrupters competing against traditional banks. Several of them focus on

innovative technology and rapid service and are attracting a whole new segment of consumers who are not

necessarily the core strength of traditional lenders. Yet the more traditional banks have lower cost of funds, a long

history of consumer lending and credit modeling, significant investments in customer relationships and branch

networks, well known brands, and access to decades of customer data.

These complementary attributes open up the

opportunity for true strategic partnerships

between traditional and marketplace

lenders. Some believe that Lending as a

Service (LaaS)1 will be the model of the

future, utilizing the most efficient parts of

each company’s operations or technology

platform to create superior loan products

that offer the best prices and service to

customers. As banks progress beyond simply

investing in marketplace loans, these

partnerships will take many forms, from

basic referral programs to white labeling

and joint product development. Each type

of partnership has the opportunity for

significant revenue benefits to each side

(and their customers!) and requires a

differing level of integration and investment.

1 Rotman, Frank. “The Hourglass Effect, A Decade of Displacement”

Lending as a Service (LaaS) is a derivation of the commonly used term ‘X as a Service (XaaS). It is often used to describe services delivered over the internet, as components, and sold as a service rather than a product. It often involves integrating different pieces of a system or process from providers who specialize in a particular area. Lending as a Service involves utilizing technology or other service providers to supply a particular component of the overall lending process.

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While the potential benefits are clear – higher returns, access to new customers, and fulfillment of obligations such

as CRA (Community Reinvestment Act), there are a few reasons why some banks have not yet pursued partnerships

with marketplace lenders yet. These include limited risk appetite, potential cannibalization of their own business,

and perceived potential reputational risks. Whichever type of partnership is pursued, there will a need for an

additional due diligence and scrutiny than is typically expected from pure investor partners. Banks have certain

regulations to comply with which marketplace lenders are not directly subject to, and banks will need insight into

the complexities and workings of marketplace lenders. Choosing the right partner to fit a bank’s strategic needs and

establishing a comprehensive framework to manage the relationship are critical to achieving synergy and success.

Below are a few examples of recent partnerships between marketplace and traditional lenders.

Recent Examples of Partnering Up

In May 2013, the US unit of a large European bank became the first high street bank to see one of the major MPL platforms as an opportunity and entered into a receivables purchase agreement that allowed them to purchase up to 25% of their originations for the next three years.

Allowed to purchase up to

25%

Community Banks found marketplace lending platforms to be their friend as they look for new sources of growth amid tight margins on lending. By partnering with platforms, community banks benefited from their low operational cost which gave them the ability to facilitate small consumer loans that they could not profitably originate and service on their own.

A Silicon Valley startup platform, valued at $1.7 billion, is drawing more than just venture capitalists and private equity but also strategic bank investors as they raised $165 million in new financing in April 2015. Investors included top 5 US and European banks.

A large European bank recognized that partnering with one of the largest US platforms was an innovative step forward in finance and actually allows some of their clients to buy parts of loans originated on the marketplace platform.

In April 2015 one of the largest US banks announced a partnership with an MPL (Marketplace Lending) platform to originate loans specifically designed to meet the bank’s CRA goals.

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Partnering to lend – Capitalizing on strengths

Most marketplace lending partnerships will begin with a financial firm or bank purchasing loans from a

marketplace lending platform based on established criteria that match the bank’s risk and return objectives with

profiles and volumes that the platform is able to produce. As the partnership matures, the partners become more

comfortable and familiar with each other and more strategic opportunities are identified, leading to additional

depth and integration. Lending as a Service (see figure 1) may be the model of the future, wherein banks and

platforms would each identify their core competencies and areas of opportunity and determine the best mix of

services that each can provide. For example, they could work together on attracting new customers: the

marketplace lender can be responsible for the application, underwriting, closing, and credit modeling process,

while the traditional lender might use their scale and expertise to handle servicing and collections functions as well

as the identification of opportunities to cross-sell products and services and provide financial advice to the

customers.

Figure 1

Customer Acquisition

Application, Underwriting, Closing

Credit modeling process

Servicing and collections

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Referral programs

A form of partnership beyond buying loans is a referral program wherein banks and marketplace lenders refer

prospective borrowers to each other. When a potential customer applies for a loan but does not fit the credit profile

or other specifications of one lender, they can be referred to the other. This may involve an initial decline, with the

lead then being passed to the other lender, or the borrower being presented contact information for the alternate

lender. Ideally though, this would be a seamless transition wherein the borrower would be redirected within the

online application to a co-branded partner website that presents the borrower with their loan options and next

steps. Consideration should be given to borrower experience and messaging, alignment of the speed of funding and

other parameters with regards to the original loan, and to privacy and data sharing requirements. Such referral

programs can create fee revenue, but also allow banks and lenders to provide a more full-service offering to meet

their customers’ needs.

Imagine, Jacob has been operating a wildly popular food truck for the past year and is looking for a $25k loan to purchase another truck to expand his business. He walks into the local branch of the bank where he has his checking account and mortgage loan to discuss his options. Banker Mary tells him that while they only make loans to businesses with at least two years of operating history, their lending partner has some great business and personal loan products. She shares the details of the partner programs, along with some promotional materials. When Jacob finishes asking questions and says that the partner’s loans sound like they will meet his needs, Mary hands him a tablet and brings up the loan application screen. Jacob spends about 15 minutes at the branch inputting relevant information, with Mary helping to answer questions along the way. The bank receives a referral fee from the platform, along with the benefit of having helped one of their loyal customers meet his financial needs. Through his various interactions with Mary, Jacob realizes that he could significantly lower his credit card processing costs by moving over to the bank, and eventually also moves his investment accounts.

Customer Acquisition

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White labeling

White labeling is a deeper form of partnership in which

the platform is providing technology to act as a virtual

extension of the bank. White label partnerships may be

effective when a bank has little to no current presence

in a lending asset class, or when an institution doesn’t

have the budget to start up a new business line that

would require significant investment in technology and

operations.

White label partnerships could be developed to handle

the loan process from beginning to end, including

customer acquisition, processing, and servicing

functions, or might only involve a technology layer to

support a bank’s own marketing and processes.

From a customer experience perspective, that platform

is the bank. Because of that, there are significant

implications in terms of service quality, branding

cohesiveness, and compliance considerations. Yet, from

an operational perspective, the two entities still operate

separately and must skillfully navigate complex

workflows which touch both parties.

Imagine, Jane is about to start her first job and is moving across the country for it, but she needs some extra cash to pay for moving expenses – quickly. She knows just where to look – Jane logs on to her bank’s website, goes through a loan application and within a few minutes, she is approved. The process is easy to understand and she can chat with a customer service agent with the click of a button.

After logging in to her bank, she was actually redirected to a bank branded version of platform X’s website. Platform X provides all the technology for the Bank to support this customer friendly lending process in a seamless way.

The Bank has found a partner with the platform they need and only pays a fee-per-loan, minimizing their up-front investment.

Application, Underwriting, Closing

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Joint product development

Joint product development between banks and marketplace lending platforms could take many forms, depending

on the needs and strengths of each partner. It might involve developing credit products that a marketplace lender

might not typically offer, but that meet the specific needs of a bank. One current example of this is a platform that

has an agreement with a large national bank to originate and sell to the bank loans that fulfill required CRA goals.

Collaborating on joint development of new credit models is another possibility for partnerships – where banks and

marketplace lenders could use their diverse assets of alternative data, bank proprietary data, along with traditional

credit bureau data to develop advanced credit models.

Imagine, Regional Bank has a long history of always being there to meet their customers’ financial needs. They offer a wide variety of products and have collected extensive financial and transactional data on their customers over decades of relationships. Yet they are finding that some of their younger customers don’t use many banking products and don’t have very long credit histories. Regional Bank wants to ensure that they can continue to meet these customers’ borrowing needs, but feels they don’t have all the data to make informed, risk-based decisions.

Regional Bank decides to partner up with Platform Y to create a credit scoring model that combines the depth of data from Regional Bank’s years of customer relationships with social and other non-traditional data that Platform Y has developed expertise and a track record in utilizing in order to make effective credit decisions. Both companies are able to leverage each other’s strengths and assets to advance their own business needs.

Credit modelingprocess

Servicing and collections

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Identifying a Strategic Partner

Partnerships to provide capital or purchase loans

require banks to have a good understanding of

marketplace lenders’ credit standards, underwriting

processes, and compliance and quality controls. Yet

strategic partnerships require even more up-front

investment, have a longer time horizon, and have a

lasting impact on overall product, customer, and

revenue potential for both partners.

There are a variety of reasons why a bank or traditional

lender may want to partner with one of the marketplace

lending platforms, and based on those goals they may

look for partners where there is already an alignment,

or conversely, they may look for a partner with

complementary features.

By identifying the categories to consider, lenders can

effectively outline their goals for a strategic partnership

and begin identifying possible partner companies.

Once goals for the partnership have been clearly

established and possible target companies have been

identified, it is time to take a closer look at the target

companies to assess internal factors which could point

towards a good match. These factors include

compliance rigor, operational efficiency, risk

management discipline, culture, credit risk appetite,

and reputation, just to name a few. Banks must

carefully vet any third party for compliance with all

applicable laws and regulations, overall customer

service, and operating model and rigor around risk

discipline. Each entity must also be mindful of the

proper transfer and safeguard of customer data,

particularly in light of the increase in cyber attacks. By

ensuring that the marketplace lending partner has the

appropriate processes and controls in place, banks can

gain comfort that the partnership will provide long term

accretive benefits.

Considerations such as operational efficiency and

technology scalability will be indicators of a platform’s

ability to grow and succeed beyond the startup stage.

With the high-volume, smaller dollar nature of many

marketplace loans, manual tasks and operational

inefficiencies will be magnified as platforms begin to

grow. Any technology deployed must be able to quickly

scale to handle large volumes, and operations should be

streamlined and automated as much as possible.

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Evaluating potential partners

The framework below provides a guide to banks and

other financial firms to help assess potential

marketplace lending partners. It also provides a guide

to marketplace lending platforms who are looking

toward strategic relationships with a bank to prepare

for due diligence.

The due diligence of platform partners should be

holistic and detailed and include such elements as

company history, operational competency, technology,

financial stability, credit risk management, enterprise

risk management capabilities, compliance management

program, quality control program, and servicing and

collection practices. These elements should be

thoroughly assessed and evaluated, may be performed

by a third party, and likely will involve a series of data

analysis, documentation review, and on-site meetings

with management to delve into areas of question or

concern.

With respect to bank-marketplace lender partnerships,

regulatory compliance is an area of specific focus. An

effective Compliance Management System (CMS)

establishes the framework for identifying, assessing,

controlling, monitoring and reporting compliance risks

across the platform, and will give a bank partner

confidence in the the platform’s ability to manage key

compliance risks.

Key CMS elements include:

Key elements

Board & Senior Management

Oversight Responsibilities

Standardized Policies &

Procedures

Training

Monitoring & Corrective

Action

Consumer Complaints Data Mining

and Management

Independent Compliance

Testing

Third Party Oversight

Privacy and cyber security

elements

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An effective compliance management system is the

foundation for any organization to succeed at risk

management, however there are number of additional

considerations specific to partnerships between banks

and marketplace lenders.

Initial partnership due diligence should also include

financial due diligence, including a requirement for

audited financial statements which demonstrate

financial stability and ability to meet obligations and

continue growth. Additionally, banks may require a

detailed understanding of the credit policy,

underwriting process, fraud prevention mechanisms,

and the credit model being used, including actual loan

performance history and stress testing under various

economic scenarios.

Platforms should be prepared to provide their potential

bank partners with access to transparent and detailed

reporting and data feeds that allow insight into portfolio

performance, referral performance, or other data

related to the subject of the partnership. Regardless of

whether the data is provided directly or through an

intermediary, the platform and bank should have

technology in place which allows them to efficiently

communicate and receive information, in order to

maximize customer service, sales opportunities, and

risk management capabilities.

This reporting and data sharing should be coupled with

ongoing performance and risk monitoring to maintain

regulatory compliance and ensure that the expected

return in investment is being realized. This may include

tracking agreed-upon key performance and risk

indicators as well as adherence to service level

agreements.

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The opportunities posed by partnerships between marketplace lenders and banks are significant, however

integrating the business relationships strategically is the key to success. With our deep banking and consumer

lending knowledge, and experience with marketplace lending activities, we can assist in preparing for such a

partnership, from conducting market assessments, to evaluating various partnership strategies, or conducting due

diligence and advising on regulatory compliance matters. Regardless of whether your organization chooses to

partner with a bank or marketplace lender, we can provide advice and support on the critical decisions and key

implementation activities that will shape your strategy and help position the partnership for success.

Due Diligence

• Strategic fit assessment

• Risk and compliance assessment

• Bank oversight and monitoring readiness

• Third party risk management

• Financial and operational assessment

Strategy

• Partnership strategy and goals

• Market entry strategy

• Customer experience strategy

• Alternative data and social media strategy

• Cross selling and relationship deepening opportunities

Technology

• Requirement definition

• Process and technology integration

• Origination and servicing automation

• Managed testing service

PwC Offerings

Operations

• Operating model alignment

• Data structuring and transfer between parties

• Credit Risk modeling and underwriting validation

Regulatory

• Compliance management system design

• Third party risk management

• Fair lending assessments

How PwC can help

To discuss a range of services tailored to your organization’s needs, please contact:

Roberto Hernandez Principal Consumer Finance Group

Telephone +1 940 367 2386

Email roberto.g.hernandez@pwc.com

Linkedin https://www.linkedin.com/ in/robertohernandez1

Jason Chan Senior Manager Consumer Finance Group

Telephone +1 214 435 1161

Email jason.chan@pwc.com

Linkedin https://www.linkedin.com/ in/jchan14

Mackenzie Sullivan Manager Consumer Finance Group

Telephone +1 213 217 3612

Email mackenzie.sullivan@pwc.com

Linkedin www.linkedin.com/in/MackenzieSullivan1

Will marketplace lending be ready for increased regulatory scrutiny?

http://pwc.to/1IuOFPw

Peer pressure: How peer-to-peer lending platforms are transforming the consumer lending industry

http://pwc.to/1D6DrNT

Is it time for consumer lending to go social?

http://pwc.to/1CqOZgp

www.pwc.com/consumerfinance

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