What does recession mean to digital lending companies

According to the IMF, global economic growth has fallen from 3.4% in 2022 to 2.8% in 2023. Developed countries have experienced a strong economic slowdown from 2.7% in 2022 to 1.3% in 2023. In an alternate scenario where the financial sector continues to be instable, global growth is projected to decrease to around 2.5% in 2023, while the growth of the developed countries is expected to decrease even more below 1%, says the IMF. Moreover, global inflation has faced a downward slope, falling from 8.7% to 7% in 2023. Yet, it is predicted that it will fall very slowly. The return of inflation to the target is not expected to happen before 2025.

In May 2023, the consequences of it were seen in Germany, Europe’s largest economy, as it entered a technical recession. Data from The Federal Statistical Office demonstrated a decline in the GDP from 0% to -0.3% during the beginning of 2023. In the last quarter of 2022, Germany recorded a 0.5% decline in GDP and after that two other negative growth rates occurred, thus, indicating a technical recession.

As a response to the high inflation rates in Europe, the ECB has increased the interest rates across the region as well. The rates have increased by approximately 375 basis points since July 2022. The Global Financial Stability Report of the IMF shows that with the increasing interest rates, the risk to banks and digital lending businesses has increased as well. In the past, central banks’ rapid increases in rates have often been followed by pressures that expose financial system problems.

A crisis different from the one of 2008

Unlike the global financial crisis of 2008, when technology played a limited role, the current economic situation is marked by a significant shift in where technology plays a crucial role. This change enables digital lending companies to incorporate their financial tools directly into the software of B2B ecommerce platforms and marketplaces. Because of that, the accessibility of such financial services is increased, particularly in the places where the B2B transactions take place.

One advantage of the integration of technology in finance is the ability to use real-time data that is shared during transactions. This streamlined exchange of information helps businesses accelerate the borrowing process, making able for consumers or SMEs to access funds more quickly and efficiently. As a result, they can use those funds to invest in their operations and increase their productivity.

Default Rate

With rising interest rates, borrowers might find it more difficult to repay the loans they took via digital lending companies. This would result in a rise in the default rate, which would be detrimental to the loan portfolio and profit margins of digital lenders. The US and European default rates are expected to rise to 3.75% and 3.25%, from 1.6% and 1.4% one year before, according to the S&P rating agency. It is also anticipated that customers of digital lending companies will adopt a similar strategy.

Cost of Capital

Changing interest rates play a crucial role in borrowers’ behavior, resulting in a potential decrease in demand for loans. Increasing rates might negatively affect borrowers’ decision to take new loans or refine existing ones. As the cost of borrowing increases, consumers and SMEs may reduce their borrowing needs, leading to a decrease in demand for digital lending companies.

Loan Pricing Models

To respond to the changes in interest rates, digital lending companies might need to adjust their loan pricing models. They might adopt higher interest rates on their loans to compensate for the increased risk and other costs related to lending during periods of high inflation. This approach could reduce the demand for loans even more.

Investor Perspective

Digital lending companies tend to attract investors by offering alternative financing options. With the rising inflation and interest rates, investors might shift away to different investment avenues that provide higher/stable returns, such as bonds or traditional banking products. However, they have an optimistic approach as they expect a decline in inflation without much higher interest rates. Even though investors see an economic recession as present, they still expect it will not be very deep.

Regulatory Framework

In times of rising inflation and rates, regulations may become stricter in order to mitigate potential risks to borrowers. In this framework, digital lending companies might be required to meet additional compliance requirements, leading to increased costs.

Tactics for Overcoming the Recessionary Challenges

To overcome the risks that digital lending companies face from the current economic recession, digital lending companies might consider the following tactics:

1. Personalized Solutions

Using customer segmentation data to anticipate and handle the specific needs of individual consumers effectively is essential. Digital lending organizations can acquire significant insights into their client base’s different demands and preferences by evaluating and categorizing them into distinct categories based on their features, interests, and actions. This allows them to develop customized solutions for customers, increasing borrower satisfaction and loyalty.

2. Risk Management

To minimize the effects of increased default rates, digital lending organizations can use advanced data analytics and machine learning approaches (Exaloan can help!). By doing this, they enhance their evaluation of the creditworthiness of the borrowers. This strategy entails strengthening their risk management procedures and improving their loan underwriting criteria even more. These steps are necessary to mitigate the effects of rising default rates and to guarantee a more accurate assessment of borrowers’ loan repayment capacities.

3. Diversification

By broadening the loan products and diversifying the borrower base, digital lending companies can reduce their exposure to certain sectors of industries that might be more sensitive towards increasing inflation and interest rates. This method enables businesses to spread their risk, safeguard their portfolio, and more effectively overcome the obstacles offered by a changing economic environment.

4. Flexibility

Borrowers who have concerns about higher inflation and interest rates may be attracted by more flexible repayment options and refinancing alternatives. If digital lending companies provide their borrowers with variable rate loans or adjustable interest rates linked with the market benchmarks, the borrowers will have more options. This flexibility allows borrowers to possibly benefit from lower interest rates, lowering their overall borrowing costs.

5. Cost Reduction

Digital Lending companies can improve their financial efficiency and reduce their funding expenses through a variety of methods. One method is to prioritize operational cost optimization, which entails identifying areas where expenses may be lowered without sacrificing productivity or quality. This could entail optimizing operations or implementing cost-effective technologies to uncover possible savings. In addition, they might look for new partnerships or collaborations that will help them reduce costs by sharing resources and gaining expertise.

6. Transparency with Investors

It is important to maintain open channels of communication with investors on risk mitigation strategies, loan performance, and the company’s ability to handle rising interest rates and inflation rate risks. Transparent reporting and regular updates are critical in establishing and keeping investor trust. They offer investors the information they need to analyze the company’s financial health, risk management strategies, and overall performance.

7. Regulatory Standards

By staying up-to-date on regulatory standards and actively interacting with regulatory organizations, digital lending companies can navigate the compliance landscape more easily. They can develop trust with both borrowers and investors if they are proactive in addressing various regulatory concerns in time.

Conclusion

To conclude, the current economic situation, characterized by slow growth and rising inflation and interest rates, has important implications for digital lending companies. They can confront risks such as greater default risk, lower loan demand, higher cost of capital, and changing loan pricing models. Apart from these, investors may seek alternate routes for higher profits, and regulatory frameworks may become more stringent. To address these risks, digital lending companies can use tactics like personalized loan solutions, leveraging data analytics for risk management, loan portfolio diversification, repayment options flexibility, transparency with investors, and compliance with regulatory standards. By employing these tactics, digital lending companies can reduce their risk exposure and effectively navigate the shifting economic landscape.

All in all, the future of digital lending is promising and holds great potential. According to SNS Insider, the market will be worth USD 34.7 billion by 2030, with a 12.6% CAGR. Despite the challenges faced by the current economic situation, digital lending companies offer considerable growth opportunities. By capitalizing on their technological strengths, addressing risk management, and building investor relationships, digital lending platforms can emerge stronger after the recession. These platforms’ ability to provide efficient financial solutions positions them as important players in the financial landscape, leading to economic recovery.

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What does recession mean to digital lending companies

A crisis different from the one of 2008

Tactics for Overcoming the Recessionary Challenges

Conclusion

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