Digital lending leaders should always be prepared for a liquidity crunch

By Danielle Sesko, Director, Product Management TruStage™

The severity of a liquidity crunch for digital lenders cannot be overstated, as it poses significant challenges to their operations and the broader financial ecosystem. When liquidity becomes scarce, it can lead to a vicious cycle of reduced lending capacity, decreased revenue and increased default rates.

Additionally, the digital lending industry often attracts a wide range of borrowers, including those with limited access to traditional banking services. A liquidity crunch in this sector could disproportionately affect underserved populations, exacerbating financial inequality.

Economic pressures influence digital lending

Navigating the current inflationary environment is a paramount challenge for lenders in today's economic landscape. As inflation rates surge, lenders are compelled to reassess their interest rate strategies to maintain profitability while also ensuring borrowers can shoulder the increasing cost of borrowing. The rapid rise in consumer prices can erode the purchasing power of borrowers, making it imperative for lenders to strike a delicate balance between charging rates that reflect rising inflation while avoiding discouraging borrowing altogether. Moreover, lenders must adapt to changing consumer spending habits, as inflation often prompts consumers to modify their purchasing decisions.

The ongoing workforce challenges — including layoffs, remote work disruptions and shifting employment patterns — pose a significant concern for lenders. As companies grapple with these issues, lenders must consider how these workforce dynamics can impact borrower repayment capabilities and default rates. Layoffs and job instability can directly affect borrowers' financial health and their ability to make regular loan payments. Lenders should consider implementing comprehensive risk assessment strategies to identify borrowers who may be more vulnerable to economic shocks stemming from workforce changes.

How to spot a liquidity crunch

At the root of a liquidity crisis is widespread portfolio mismatching among banks and other businesses, resulting in a lack of cash and other liquid assets. Liquidity crises can be triggered by large, negative economic shocks or by normal cyclical changes in the economy. Digital lending leaders can be better prepared for liquidity crises if they know how to spot them.

Perform routine assessments

A comprehensive assessment of lending portfolios is crucial for financial institutions to navigate the complexities of a volatile market. By scrutinizing their lending portfolios, digital lenders can identify areas of potential risk and opportunity, enabling them to make well-informed decisions. This assessment involves evaluating the creditworthiness of borrowers, analyzing the performance of existing loans and assessing the diversity and maturity of loan types. By identifying potential weaknesses or concentrations within the portfolio, lenders should be able to proactively manage risks and allocate resources more effectively.

Challenges digital lenders face during a liquidity crisis

During a liquidity crunch, digital lenders will need to be prepared to face a slew of challenges. Getting creative to improve operating efficiency across the company should be the top priority. Without this, the continued success of the company is in jeopardy. Let’s review the top pain points digital lenders should have an action plan for in the event of a liquidity crunch.

Low customer acquisition cost (CAC)

In the fiercely competitive landscape of digital lending, keeping the CAC low is crucial to remain competitive. Lenders need to develop and implement cost-effective marketing strategies to not only attract new customers but also to retain them. By efficiently targeting potential borrowers and reducing the costs associated with acquiring them, financial institutions could bolster their bottom line during challenging times where every dollar counts.

Loan portfolio resiliency

In the ever-fluctuating economic landscape, the resilience of a lender's loan portfolio is of paramount importance. Building a resilient loan portfolio requires a multifaceted approach. Diversification of risk is crucial; lenders should spread their loans across various industries, geographies, and creditworthiness levels to minimize the impact of downturns in any particular sector. Stress testing, using historical data and hypothetical scenarios, helps lenders assess how their portfolio might fare under adverse economic conditions, allowing them to make informed decisions to mitigate potential losses.

Attracting new customers

Attracting and retaining borrowers is a perennial challenge for lenders, particularly in the digital age. To succeed in this, financial institutions must enhance their digital capabilities, creating a seamless end-to-end experience. From streamlined loan application processes to user-friendly mobile apps, borrowers expect convenience and efficiency. Additionally, lenders should be attuned to evolving consumer needs and preferences, offering flexible loan products that can adapt to changing circumstances, such as payment protection products for that could benefit borrowers and lenders.

While digital lending has given more borrowers access to credit, the threats imposed by a liquidity crunch should remain top of mind for digital lending leaders. As this industry continues to grow, it’s imperative that leaders stay proactive by conducting routine portfolio assessments while monitoring changing economic conditions to accurately predict the next liquidity crunch.

The views expressed here are those of the author(s) and do not necessarily represent the views of TruStage.