Over the last decade, specialized consumer finance companies have expanded financial inclusion by providing credit access to consumers whom banks had overlooked. In many geographies, they have provided huge pools of retail customers with financial services for the first time. In some emerging markets, they provide more than a third of retail lending.1 In some markets, they supply more than 80 percent of lending for retail segments such as automotive and consumer durables.
These entities came into existence and prospered primarily because, in many geographies, they had lesser regulatory burden than banks, for instance having more relaxed capital adequacy requirements and fewer rules around fraud management. This created a space in which they could operate alongside traditional banks and lend in regions where banks found it difficult to operate. In many economies, consumer finance companies targeted markets that were neither accessible to nor a priority for banks, such as low- and middle-income populations or younger populations new to credit. To access these segments, they layered discretionary consumption spending with financing options and enhanced distribution by building relationships with offline merchant partners in categories such as consumer durables and automotive. Over the years, consumer finance companies have invented and refined the art of point-of-sale lending for customer acquisition and constructed proprietary underwriting engines based on repayment information.
However, the business model of established nonbank financial players is experiencing significant stress. Heightened regulatory pressure and rising interest rates are depressing margins. Competitors have multiplied; independent software vendors (ISVs) are offering specialized point solutions to strengthen retailers’ lending capabilities, and digital merchant platforms are capturing adjacent customer lending pools. Meanwhile, the advent of gen AI is helping banks and fintech companies accelerate their learning curve in consumer finance by employing, for instance, statistical tools that use existing market data to support accurate and timely underwriting.
Key disruptions affecting consumer finance companies
The business model of consumer finance players is teetering on the brink of disruption, but these lenders can navigate this critical juncture by significantly reimagining their business and operating models. There are several challenges to consider.
Customers increasingly expect a more digital experience
Customer preferences shifted significantly during the COVID-19 pandemic. The demand for online financial service products has increased substantially. Exploration journeys, even for complex products such as loans and insurance, start with search engines, videos, and vendor websites. More than 60 percent of consumers in advanced economies, particularly in Europe, prefer to purchase financial products online rather than in person.2 As these preferences become more important in other geographies, they will increase the imperative for consumer finance companies to enhance the customer experience.
Data and technology let banks move down the consumer pyramid
Banks face heightened competition from digital disrupters in their traditional affluent customer segments. Meanwhile, the increasing democratization of customer data and the advent of gen AI have given them visibility into mass-market segments, motivating them to target the mass and lower-mass segments traditionally serviced by consumer finance players. Increasing competition in these segments may erode the market share of specialized consumer finance companies, forcing them to reconsider their pricing strategies and become more efficient.
Digital-native fintechs and e-commerce majors are competing aggressively
Digital-era lending fintechs have acquired substantial user bases through digital marketing. They initially built customer trust by offering seamless digital journeys for everyday use cases such as personal finance management and bill payment, then gradually added consumer loans. One large Asian player built a customer base of more than ten million and a loan book of $2 billion in just five years by providing tools such as credit card bill payments and credit score trackers.
At the same time, large direct-to-consumer (D2C) commerce platforms, such as Amazon and eBay, have introduced credit offerings that leverage white-label tools from vertical software providers. These B2C e-commerce companies use proprietary data, including customer behavior, intent, and earning potential, to provide customized credit solutions to their customers at the point of sale. These digital-native players have substantial talent pools in digital, data engineering, and data science that will give them an advantage in harnessing the power of artificial intelligence.
Alternative lending models are surging
Alternative lending models, such as peer-to-peer lending and venture debt, were once considered niche. However, they have now entered the mainstream as they are adopted by retail investors on both the supply and demand sides. These lenders, no longer operating in the shadows or in gray areas, have garnered the attention of regulators, who are drafting policies and frameworks that are bolstering confidence and attracting capital. As their platforms further democratize access to credit with more personalized lending solutions, these lenders may capture market share from specialized consumer finance entities.
Regulatory scrutiny is tighter, and interest rates are higher
Loan-to-deposit ratios in many geographies surged when central banks lowered rates during the COVID-19 pandemic, prompting legislators to enact rules to ensure the sustainability of credit growth. Many of these rules have raised capital costs and reduced the compliance cost advantage that consumer finance companies previously enjoyed over banks. The rapid increase in interest rates over the last two years in many geographies has put further stress on consumer finance companies’ cost of capital and ability to compete with banks.
A six-point plan for navigating the new reality
Owing to these disruptions, consumer finance companies’ traditional business model, with its high operating expenses, is becoming obsolete. To be competitive, players need a smarter business model that better leverages their cost base and maximizes their business with existing customers. They can achieve superior economic performance by transforming their business model with the levers in each of the six key dimensions in Exhibit 1. Some are already doing this; as companies reach different levels of maturity, some are charting the way and setting examples for others.
1. Funding model
To stay competitive in evolving regulatory landscapes and high-interest environments, consumer finance companies require new funding models. They can explore a range of solutions, including securitization, co-lending arrangements, alternative funding sources, and more, to equip themselves for the new paradigm. For example, many are creating lending portfolios committed to environmental, social, and governance objectives, such as solar panels and electric vehicles, which can lower their cost of funds from global institutions.
2. Product proposition
Players can pursue several new product propositions, including new product categories and innovative open lines of credit.
Expand into new high-ticket categories. Aside from being expensive, traditional customer acquisition at offline points of sale provides limited opportunities to differentiate offerings. But in some regions, high-margin categories such as luxury apparel, aesthetic treatments and procedures, and home fitness equipment have proven a good fit for consumer financing.
However, specialized finance players cannot directly apply their existing operating models, which are typically tuned to low- and middle-income customers, to these mass-affluent and affluent segments. Leading players are building credit solutions tailored to the specific needs of each category. For example, one Asian consumer finance player has established a healthcare loan offering that lets patients align real-time financing with their treatments.3 For instance, they can schedule payments to coincide with follow-up visits for treatments like root canals, making follow-up visits more affordable, reducing noncompletion of treatment, and ensuring a higher volume of business.
Offer open lines of credit. Historically, dedicated consumer finance companies have offered standard preapproved personal loans with limited customization or personalization. To compete with tailored offerings from agile fintechs, specialized consumer finance players need open lines of credit that can adjust limits and repayment terms based on user behavior in real time.
Dedicated consumer finance players can learn from large private-sector banks that provide lines of credit on open-banking digital payment rails in India. These banks are transforming the payment experience into form factors, such as credit cards that offer rewards for higher spending. Meanwhile, consumer finance players are developing bundled solutions, such as four-in-one products that allow consumers to access a single credit line via a savings account, digital wallet, credit card, or prepaid store card. In Northern Europe, consumer finance companies have achieved significant success in offering debt consolidation and debt transfer from less favorable finance products.
3. Customer acquisition
Tools for increasing customer acquisition include ownership of the full marketing and sales funnel, omnichannel integration, and digital marketing.
Own the funnel with digital ecosystems. As purchasing shifts to digital channels and D2C merchants offer in-house financing, many consumer finance players have established digital ecosystems that enable consumers to access vendors’ brand catalogs and initiate online-to-offline (O2O) interactions. These platforms reduce financing players’ dependence on merchant partners, help them own the marketing and sales funnel, and generate data on customer behavior. Leading players have shown that increasing engagement to encourage repeat usage can help amortize the costs of the first sale over a longer relationship.
For example, a leading Asian player aggregated offline consumer durable retailers and enabled online discovery of their catalogs.4 It incorporated engagement hooks for consumers (for example, monthly installment planners for their total borrowing), thereby encouraging consumers to finance and reducing the company’s dependence on offline acquisition.
WeiYeDai (“small-business loan”) is an unsecured loan offering accessed via text on China’s largest internet-based messaging ecosystem. It has grown rapidly since its launch in 2017 and is now one of the country’s most accessible sources of financing. The company owns the full funnel for its customers, actively communicating with and nudging them along the entire buying journey from catalog to discovery, payments, and lending.
Integrate the customer experience among channels. Customers in every geography pass through multiple touchpoints before closing a purchase. Even in emerging economies, more than 85 percent of customers start by exploring financial services products online, and they increasingly expect seamless, hassle-free handoffs between channels. Also, they want to complete their journey with a personalized experience, whether through a call with an agent, on a lender’s website or app, or by visiting a nearby branch.
Regardless of the route a customer takes, consumer finance players can drive conversions by marketing to individuals as soon as they begin their product journey. Integrated technology stacks that combine product journeys with real-time underwriting are crucial to delivering omnichannel service.
Scale new customer acquisition with digital marketing. As competition from digital-native platform players and incumbent banks intensifies, it will be critical for consumer finance players to use digital marketing to scale up while containing their customer acquisition costs. Performance marketing, including keyword and advertising strategies, can expand the top of the marketing funnel, while personalized retargeting powered by analytics can increase the conversion rate throughout the life cycle.
To maximize the effectiveness of digital marketing by, for instance, determining the best outreach strategy and next action for each customer, players can profile customers based on internal and external data sources. A leading consumer finance player in North America created granular customer segment profiles to improve engagement. It identified untapped niche segments, such as university students and recent immigrants, and launched a large selection of cards with rewards tailored for each segment. Even the company’s communication plan, from landing pages and channels to messaging and delivery, was devised and executed based on microsegment personas to achieve a high conversion ratio.
4. Underwriting
Efficient and accurate underwriting will be a key to competitive lending for consumer finance players. Implement real-time, customer-level underwriting. To embed point-of-sale (POS)–based lending in digital platforms, consumer finance players need an underwriting engine that can make go/no-go decisions in seconds. The engine needs to base decisions on each customer, with visibility into the person’s total credit exposure and a limit for each that can be adjusted in real time for any lending product, considering the purchase amount, location, and intent. The underwriting engine must have access to multiple data sources, including internal and partner data, as well as external data such as that from credit agencies via API calls (Exhibit 2). It should also incorporate real-time feedback loops to enable continuous improvement.
5. Collections and recovery
An important foundation for effective collections and recovery is a microsegmented customer base.
Deploy smart customer microsegmentation. Many consumer finance players have extensive customer bases, which are increasingly stressed by, for instance, inflation. We believe these entities can no longer rely on their traditional, labor-intensive collections approach. However, they can leverage sharper analytics, based on internal and external data sources, to microsegment customers and determine contact and treatment strategies for each segment.
Microsegmentation can help distinguish customers who can resolve late payments themselves—for instance, with automated prompts and incentives—from those who require intervention from a call center or field team. AI and gen AI can enable a personalized strategy for each customer, including communications tailored down to the style and tone of messages from a collections agent. Exhibit 3 illustrates how an emerging Asian player tailors its channel and messaging strategy to different segments. This lender employs week-long outreach strategies, each tailored to a customer microsegment and comprising a mix of digital, SMS, and telephone interactions with an empathetic, urgent, or informative tone, as appropriate in each case.
Gen AI can improve the efficiency of collection processes by supporting agents. It can track every call, interpret context, identify patterns, and analyze sentiment to give agents timely and actionable feedback, significantly improving operational performance and service quality.
Also, gen-AI-enabled bots can provide a completely digital channel for customers who might resolve their late payments without the involvement of collections staff. The bots can send reminders and suggest solutions, adapting their scripts in real time based on customers’ responses. Players in Asian markets have seen two- to three-times improvements in “self-cure” rates, with 20 to 30 percent lower costs per account.
6. Customer engagement and cross-selling
Two important techniques for retaining and nurturing the existing client base are preapproval and value-adding tools.
Use preapproval scorecards to generate repeat business. The traditional consumer financing model relied on lenders’ ability to cross-sell high-ticket loans to customers after their initial purchase, but few players do it well. To achieve second or third product sales within their existing customer base, companies need to create superior customer engagement and launch tailored, preapproved product offers with simple two-click journeys.
A large consumer finance player in Asia undertook an AI transformation to stimulate growth within its existing customer base. It built preapproved scorecards for unsecured loans for active and inactive customers, leveraging external data and AI to determine which credit line might best suit each segment. This initiative doubled the company’s cross-selling business and increased overall growth by more than a third.
Reengage customers with hooks and prompts. The existing customer base is a company’s biggest asset, so nurturing it is crucial. Players can better serve and engage their existing customer base through apps with value-adding features such as credit score checks and savings calculators for electronic money transfers. Some have loyalty programs and cashbacks to incentivize their customers to use their products again.
The consumer finance landscape is undergoing a profound transformation in response to technological advancements, evolving customer expectations, and new competitive forces. To thrive in this dynamic environment, consumer finance companies must embrace change and adapt their business models. By investing in digital ecosystems, AI-powered solutions, and personalized customer journeys, these players can position themselves for continued success in the years to come.
But the future of consumer finance isn’t just digital; it’s also Darwinian. Companies that evolve, embracing AI and hyper-personalization, will thrive in this new ecosystem. As for the rest, the extinction event for outdated lending models has already begun.
