Digital lending has transformed the borrowing experience, making loans more accessible and faster for small business owners. As more borrowers seek small business loans online, small and regional banks must consider a digital lending system to stay in the game. But, in doing so, it’s essential to manage the risks of digital lending.
This article will explore digital lending and identify the emerging risks for banks and borrowers. Then, we’ll review some steps your team can take to manage those risks.
What is Digital Lending?
Digital lending provides loans online through software and technology, reducing the need for manual processes.
Information about the borrower and loan request is entered into the platform, which then determines:
- Creditworthiness and risk assessment
- Loan eligibility and appropriate loan offers
- Loan amount, interest rates, and repayment terms
The process is often automated, shortening the loan application process and helping borrowers access funds more quickly than traditional methods.
Benefits of Digital Lending
Digital lending provides several key advantages for financial institutions and borrowers:
- A more extensive reach to small business owners
- Streamlined processes with reduced manual work
- Faster loan decisioning and funds disbursements
- Improved customer experience
- Flexible and scalable funding solutions
Why Risks Are Growing in Digital Lending
Today’s small business owners want fast, easy financial services to grow their companies. To keep up, more banks are using digital tools to better serve their business clients.
These tools include:
- Automation: Technology that handles tasks without people.
- Artificial intelligence (AI): Technology that helps people make decisions, like credit scoring and checking for risks
- Application Programming Interfaces, or APIs: Software that allows systems to work together
These tools streamline the application process and speed up loan decision-making.
While they offer many advantages, they also come with risks. Rushing to approve loans can lead to mistakes, especially if you use a poorly designed lending platform.
Financial institutions must balance speed with safety when choosing a digital lending system. That starts with understanding the risks.
Emerging Risks in Digital Lending
As your bank considers a loan origination system, it’s essential to understand how the risks can affect customer trust and compliance or damage your bank’s reputation.
Fraud and Identity Theft
Without in-person contact, it’s easier for fraud to occur. Criminals can:
- Use fake names and details to create new identities
- Steal money through fake loan applications
- Go undetected until it’s too late
- Complicate the recovery process
To prevent these things from happening, look for a digital lending system that includes:
- Know Your Customer (KYC) tools
- Anti-Money Laundering (AML) features
- Advanced identity checks
Data Privacy Risks
In 2024, the financial industry was hit hard. Financial companies lost an average of nearly 6 million per breach. The most common breaches involved stolen customer data, which is often used in identity theft.
Smaller banks are especially vulnerable to data crimes due to limited IT resources and the increased use of third-party vendors. Cybercriminals often see smaller financial institutions as easier targets for stealing personal and financial data.
Banks must use a digital lending system that has strong data protection measures. Without strong data protection, your bank could:
- Lose customer trust
- End up with legal problems from data violations
- Receive fines or penalties from regulators
- See an increase in stolen customer data
Regulatory Problems
Unlike traditional lending, digital platforms must address newer concerns. These include:
- Online identity verification
- Fair lending algorithms
- Secure data handling
Regulatory agencies continue to oversee compliance, but applying their guidelines to digital systems isn't always easy. For example, staying compliant with the Equal Credit Opportunity Act (ECOA) is more difficult when automated credit decisions lack transparency.
Working with a digital lending platform adds another layer of risk. Even if a bank doesn’t build the software, it's still responsible for ensuring it meets all regulations. It’s critical to choose a digital lending solution with built-in protections. This is especially true for banks with smaller teams and limited internal compliance expertise.
Underwriting Challenges
Many digital lending platforms use artificial intelligence (AI) to automate credit decisions and increase speed and efficiency during underwriting.
The risks of automated underwriting include:
- Inaccurate credit decisions
- Hidden bias against some borrowers
- Higher chances of loan defaults
- Less transparency for regulators
Great software can reduce these risks. So, it’s essential to choose wisely when evaluating software.
Working with providers who can explain how their technology works is also essential. Ask if they provide regular audits to ensure fairness and accuracy when issuing loans.
Operational Risks
A digital lending system is only good if you can rely on it to work correctly. Common problems with weak digital lending platforms include:
- Crashes or slow loading times
- Poor connection to a bank’s core system
- Lack of technical support
- No backup plan for outages
These issues can damage your bank’s reputation and cause an unpleasant user experience.
Your bank should invest in a proven digital lending system to manage these risks. The best digital lending software is reliable, user-friendly, and provides technical support. A business continuity plan is vital to avoid significant disruptions to your bank's operations.
How To Reduce Risks in Digital Lending
The risks of doing business are always there. The key is managing those risks to keep your bank and customers safe.
1. Strengthen Internal Oversight and Staff Training
Once you have a digital lending system, your learn servicing team should learn how to use it. The best digital lending software providers offer training in recognizing and managing digital risks.
Automation should never fully replace human judgment. This is especially true for complex or high-value decisions. For example, small business loan applications that fall outside standard credit criteria may require a manual review to ensure fair treatment and reduce the chance of algorithmic bias.
Regular audits are also key to ensuring fairness, accuracy, and compliance. Banks should conduct ongoing reviews of credit models, loan approval trends, and loan decisions. This internal oversight reduces risk and strengthens trust with borrowers and regulators.
2. Choose Digital Lending Software With These Features
The right software will offer customizable workflows that adapt to your bank’s lending policies and processes.
Here are some other features to look for:
- Seamless integration with your bank’s core banking system
- Built-in risk management and compliance tools
- Real-time alerts and updates for regulatory changes
- Industry-best protocols for data privacy and protection
- Automation of routine tasks and document tracking
- Simplified dashboards with real-time insights
- User-friendly, intuitive, and responsive interface for your team and borrowers
- Easy scalability
- Integrations with trusted and reputable third-party services
3. Partner With the Right Fintech Company
The right platform will deliver more than software. It offers valuable industry expertise. Look for a partner that:
- Aligns with your bank’s mission
- Has custom solutions for your bank, its loan products, and its workflows
- Helps your bank stay up-to-date and compliant
- Supports your bank’s long-term growth
- Provides support when needed
Ultimately, your Fintech partner should be invested in your bank’s digital transformation.
Conclusion
Digital lending can give your bank a powerful way to reach more small business owners and speed up the lending process. It helps borrowers get faster funding and offers tools for smaller banks and lenders to grow and compete against larger financial institutions.
However, these benefits come with serious risks. Fraud, data breaches, poor underwriting, system failures, and changing rules can all create problems if not handled properly.
To succeed, your bank must choose the right digital lending system. The best digital lending software is safe, reliable, and built with strong risk controls. Training your staff, staying updated on regulations, and working with the right fintech partner are also key to protecting your institution and its customers.
FAQs
How does digital lending work?
Digital lending uses specialized software and technology to streamline the loan process. It automates many, if not all, of the loan origination processes, including application intake, credit checks, loan approval, servicing, and more. This makes it faster and more accessible for borrowers, particularly, small business owners.
Is digital lending a threat to traditional banks?
Banks that don’t modernize their operations could get left behind. Each year, digital banking and lending become more prominent. More small business owners prefer to do all their banking online, including seeking business loans.
Are digital lending systems subject to banking regulations?
Yes. They must comply with state and federal banking laws in the same way as brick-and-mortar banks. These laws include the Truth in Lending Act and the Equal Credit Opportunity Act, among others.
How do rural and underserved small business owners benefit from a digital lending solution?
Digital lending better serves rural and credit-challenged customers, reducing the need for physical bank access. With tools like mobile apps and alternative credit underwriting, a bank can serve these borrowers while still maintaining strong underwriting standards. Digital lending also helps banks serve more customers and expand their reach.
What features does the best digital lending software offer?
The best digital lending software is easy to use and connects well with your bank’s central system. It has strong security, built-in tools to follow banking rules, and can be customized for different loan types. It also sends real-time alerts and helps track documents automatically.
How long does it typically take to implement a digital lending system at a small or regional bank?
This can depend on the digital lending system and the provider. Most digital lending platforms take three to six months to fully integrate, test the system, and train staff. However, Biz2X is much quicker than most platforms and can get a system running within 45 days.
Download our whitepaper, “The forthcoming revolution in small business lending,” to learn more about how digital lending can power up your small business lending portfolio.
