HSBC has turned to technology to make a specialized lending product that has been the preserve of the rich into something it is now marketing to its middle-class clientele.
For people who aren’t rich, the only way to obtain bank credit on favorable terms is to put up an asset as collateral, like a house. The credit officer will assess the value of that collateral, which doesn’t change. The alternative for most people would be to take out an unsecured loan, at an expensive rate of interest.
But rich people have enjoyed other options, in particular “Lombard loans”, which means loans collateralized against someone’s entire portfolio of assets.
How the rich get richer
Instead of a bank pegging an interest rate against a specific asset, they can assess the entirety of a person’s wealth. Banks prefer to lend against a diversified portfolio of assets: if stocks are down, bonds might be up, so there’s always something of value to find among the collateralized pool.
This also benefits the client, because they can enjoy a much lower loan-to-value (LTV) ratio that informs the rate of interest they pay. An LTV is the loan amount divided by the value of the collateral, so a higher value of collateral means the LTV is lower.
This is what rich people do to get even richer. They don’t sell down stocks to buy a mansion or put money into a startup. They borrow the money against the value of their assets, and use the proceeds to spend or invest.
Until recently, Lombard lending has not trickled down to the merely affluent. As part of the private bank, it is a manual process led by relationship managers in regular dialogue with clients.
Now for the middle classes
Digitization, however, makes many services once exclusive to the rich available to a wider pool of users.
HSBC has spent two years investing in the digital infrastructure to create a Lombard proposition that is fully automated. Portions of the service have been live for a while, but still required a relationship manager to introduce a customer to the service. In March, the bank introduced a front end in its retail banking app.
“Now customers can get a credit line approved on their mobile app without every speaking to a human,” said Ryan Haugarth, head of self-directed brokerage and Lombard lending at HSBC, in Hong Kong.
He has been driving the product from his previous role as head of digital wealth distribution.
The ultimate goal is to integrate Lombard lending with the broader wealth-management business for the bank’s affluent customers. By itself, Lombard lending is a credit product. But Haugarth expects some borrowers will use those funds to reinvest in brokerage products or to access wealth solutions.
Ideally that would mean the bank can generate different streams of revenues from the same client: net interest margin, transaction fees, and fees on assets under management. And ideally that the customers are benefitting from attractive LTVs on their loans (as low as 3.875 percent, quite attractive in today’s environment) plus the flexibility of using the proceeds for investing or other activities.
The bank’s credit-risk team coded the algorithm that runs the LTV assessor. “The algo’s too complicated to explain, but clients don’t ask about it,” Haugarth said. His team cannot offer advice, but the app provides customers with rules of thumb about how they can improve their LTV.
“Clients will see they’re not getting the best LTV if their holdings are too concentrated. There’s a higher haircut.” (A haircut is the difference between the current market value of an asset used for collateral and the value given it by the credit officer.)
He adds that clients will be better off in general if they respond by diversifying their portfolios, a form of de-risking. “The healthier a portfolio, the less risk of a margin call in the future,” Haugarth said.
Anyone with a bank balance of HK$1 million ($130,000) can use the service. The bank is launching Lombard loans in Hong Kong, but will probably extend it to other markets if the product works. Haugarth says the bank will need to attract “a few hundred thousand” customers to make the service viable, which he says will take up to five years.
HSBC isn’t the first consumer bank to offer a digitized Lombard lending program, but Haugarth says it can dominate this niche market in the city, thanks to its large retail base. Now that the digital infrastructure is in place, the bank needs to generate customer awareness, mainly via its consumer app.
For customers new to such products, the bank can hold some assets or cash in reserve, to cushion against a margin call. This will create a tension, however, as this will impact the LTV ratio, so customers may be eager to forego protections.
But there’s a limit to how much protection the bank can give to even conservative borrowers from the middle classes. Rich people have lots of diverse assets. Merely affluent people have fewer, so they are more vulnerable to general market downturns: if a few popular stocks take a tumble, it could have a damaging impact on their collateral’s value.
Market turmoil can lead to margin calls. This happened across the industry in the crazy spring of 2020 when Covid roiled markets, and again in 2022 when the interest-rate regime changed, tanking both stock and bond markets.
Such moments can destroy family fortunes. They are also dangerous for banks that are suddenly overexposed to big-ticket clients. Depending on the importance of the client, banks are more likely to quietly negotiate a deal that tides people over.
A traditional loan pegged to an asset (such as real estate) doesn’t get marked to market, so if the Hang Seng Index tanks, the borrower is unaffected; interest rates may vary but the borrower is solvent. But with Lombard loans, now the person’s net wealth is marked to market. Ordinary customers won’t be able to negotiate special deals.
It’s normal for the bank to take possession of customer assets when they fail to make a margin call, but it’s novel to sell such lending products to the mass affluent. It’s also novel for the middle classes to be able to invest with borrowed money using their existing assets as collateral.
If the “investor education” effort is sufficiently careful and the in-built cushions thick, this will be a good example of how digital tools can expand opportunity to new customer segments.