EY report describes fintech challenges, opportunities
While the alternative lending industry is growing in popularity and the technologies they are fostering are piquing the interest of all big financial industry players, it is easy to forget that many people involved in the financial services industry have at best a basic awareness of those technologies and their applications.
Alternative lenders have identified some core competencies they need to continue excelling at in order to continue to be successful. They must continue to simplify the borrower experience as they expand to new products and consumer segments. By leveraging big data and analytics they can continue to target underserved populations.
Two additional areas identified in the report will cause much debate in the coming years. Alternative lenders will need to keep lowering funding costs if they want to offer competitive pricing, and the best way of achieving this aim is to remove the “alternative” tag and become a mainstream asset.
If alternative lenders plan to seriously compete with the banks they have their work cut out for them, the report states.
“As bank partnerships allow alternative lenders to expand their reach, they will need to complement their current offerings with other financial products if they are to become bank competitors instead of their service providers.”
While the entire industry is essentially less than a decade old, there are some ways more established names can separate themselves in an increasingly crowded space, Mr. Kumar said.
“Some established players who have lived through 2008 such as Prosper and OnDeck have been around for eight or nine years. That is a differentiator when they make pitches to partners. A majority of players are five to eight years old and their models are yet to be proven (through an entire cycle).”
A broader question, Mr. Kumar suggested, is whether or not there is enough opportunity for all competitors. The market remains fragmented, with most entrants being niche players developing in very specific market segments. As the more successful companies seek to expand they will fundamentally change the marketplace.
“There is a ripe opportunity for consolidation and acquisitions,” Mr. Kumar said.
Ms. Singh said that most companies they met with would not share their proprietary underwriting scoring methods, but it is well known that many alternative lenders employ nontraditional inputs like social media information that borrowers voluntarily hand over. LinkedIn, Twitter and Facebook profiles reveal interesting facts. Businesses can be screened in part by Yelp reviews and data from sources such as UPS which can mined to determine seasonal differences in package volumes.
“It is striking that banks, wealth managers and other traditional institutions never took (such data sources) under consideration,” Ms. Singh said. “Kabbage has seen great success with them.”
There are a stream of economic benefits when you get a more complete picture of an individual, Ms. Singh added.
Detractors often cite an uneven playing field between fintechs and established banks in terms of regulation. Ms. Singh finds that to be a red herring.
“Fintechs are heavily regulated, as opposed to some misconceptions that they are lightly regulated. Many of the regulations that apply to them are actually the same as the banks, especially when the fintechs have to strategically partner with the banks. That is when they face more scrutiny due to the link up with the banks.
“Without complying with these regulations, the banks will not partner.”
But alternative lenders cannot blindly go all in when it comes to unique data sources, for they risk erasing a key differentiator, Mr. Kumar cautioned.
“More data is good because it helps the risk profile, but too much up front comes with a high likelihood of an increased drop-off rate.”
Using aggregation sources to capture as much key data as possible is crucial for companies wanting to send users through the acquisition funnel in a few minutes. Once those customers are further into the process the companies can get more data then.
Mr. Kumar said alternative lenders are finding success by essentially reversing the approach that FICO uses. Whereas traditional scoring methods look at the behaviors it took to get an applicant to their current spot, new entrants are taking the current position as a starting point. Given their type of education, industry and a host of other factors, how likely are they to grow and be successful?
Expect the most successful scoring models in the future to be a combination of traditional and unique methods and characteristics, Mr. Kumar suggested.
Ms. Singh said data collection and interpretation methods continue to reveal interesting nuggets of information. A client who applied at 2:00 am by googling “emergency loans” tends to have a different risk profile than a business owner who applied on a Tuesday morning at 11. Many lenders have a band the applicant can move back and forth as the size of the loan they need. Those who immediately move the bar to the high end and do not budge tend to have different profiles than one who moves it back and forth.
“They are thinking about it,” Ms. Singh said. “They are taking their time and reading it through.”
Mr. Kumar sees wealth management as a relatively untapped source of financing marketplace lenders may be able to access, especially in a low rate environment. From a broker’s perspective, they can offer marketplace lending as a new fixed income asset class.
“We believe it’s a win-win with marketplace lending as a new source of funding,” Mr. Kumar said.