Fueled by algorithms and software to assess credit worthiness, the financial technology industry’s growth has been such that regulators in the United States and elsewhere are exploring ways for these companies to test new products and innovate faster without jeopardizing the health of the financial system.
At the same time, however, there are calls from the traditional financial service sector (especially community banks) to subject these companies to the same level of regulatory scrutiny banks face, while questions continue about their potential risk to the financial system.
In such an environment, it would be a big mistake for fintech companies to maintain a low profile and focus solely on delivering value to their customers and the financial institutions they partner with. Political risks, as well as opportunities, must be factored in.
It would be a big mistake for fintech companies to maintain a low profile and focus solely on delivering value to customers and partners.
Lawmakers responsible for oversight of the financial services sector have made it clear that one of their priorities will be issues they consider to be critically important for the economic well-being of Americans. This includes encouraging what they consider “responsible innovation in financial technology,” as well as promoting diversity and inclusion in the sector. Given the heightened scrutiny on the industry from Capitol Hill, fintech companies should be actively seeking out opportunities to engage with key stakeholders in Washington, D.C. to demonstrate why their endeavors should be encouraged, not hindered.
The Federal Deposit Corporation’s 2017 National Survey of Unbanked and Underbanked Households, a report assessing “Americans’ access to safe, secure, and affordable banking services,” is an example of a perfect educational opportunity.
The report notes that 18.7 percent of U.S. households were “underbanked” last year, meaning they had an account at an insured institution but also tapped alternative financial services such as: money orders, check cashing, international remittances, payday loans, refund anticipation loans, rent-to-own services, pawn shop loans, or auto title loans.
Many of the above options come with double or triple-digit interest rates, and that is one reason U.S. regulators have encouraged banks, rather than unregulated providers, to make more small-dollar loans to customers.
The FDIC report presents a great opportunity for fintech companies, in conversations with lawmakers, regulators, and media, to underscore the key role the industry plays in making loans to under-served borrowers and communities ignored by traditional banks – and without the predatory terms common in payday and title loans. As the report notes, the majority of households using alternative financial services were in a less-advantaged group: low-income, less-educated, younger, black and Hispanic, disabled, and with volatile income.
For banks to offer small-dollar loans to these customer segments in a cost-effective manner will require partnerships with technology firms. Fintech companies can provide access to a broader range of data and analytics, potentially helping banks to serve more consumers responsibly. Richard Cordray, the former director of the Consumer Finance Protection Bureau (CFPB), recently noted how “alternative data from unconventional sources may help consumers who are stuck outside the system build a credit history to access mainstream credit sources.”
Additionally, point-of-sale lending is popular with younger borrowers, who are reluctant to take on credit card debt, but are comfortable borrowing for specific purchases. Point-of-sale lending is being fueled by fintech firms, such as Affirm and GreenSky, which have the necessary technology and also relationships with thousands of merchants. They can connect banks with borrowers.
Point-of-sale loans are an important driver of consumer loan growth for banks at a time when many are cutting back on auto lending activity and demand for home equity loans has declined. Smaller, community banks, especially, can become overexposed to specific market segments, particularly commercial real estate. Offering these types of personal loans helps to diversify their risk.
Furthermore, U.S. retail banks are closing branches at the fastest rate on record – 1,947 in 2018 alone – as consumers continue to migrate to online and mobile banking options. Clearly, the future of banking is the internet, and community banks need to partner with fintech firms to keep up with the large Wall Street banks. More to the point, without fintech partnerships, many community banks may go out of business, creating banking deserts that would be a significant blow to greater financial inclusion.
An excellent example of community banks using fintech to compete with the big banks is Radius Bank, a $1 billion asset institution in Boston, which is establishing long-term relationships with fintech providers, and is finding them to be mutually beneficial. The bank is serving more customers, and standing out from the crowd by partnering with technology firms. The bank is trying to become the Amazon of banking, but according to the article, “It’s hard for banks to reach Amazon-like levels of usability on their own.”
Many U.S. lawmakers have been vocal about their desire to end predatory lending practices, and fintech companies (and businesses more generally) need to aggressively seize opportunities such as these to show how they are part of the solution.