As anyone with even a passing interest in the banking industry knows, the financial technology (fintech) revolution has transformed consumer banking behavior – changing everything from the way individuals manage their personal accounts to how they obtain credit and pay their public and even private debts.
Indeed, fintech has already had a staggering effect on the financial services sector, and the groundswell of investment in the sector is expected to accelerate. According to research from PwC, 30% of consumers plan to increase usage of fintech providers, and fewer than four-in-ten plan to continue to use only traditional financial services providers.
This has understandably created some anxiety in the banking industry. But while the changes ushered in by fintech will pose challenges, there is good news for community banks which can actually benefit from these innovations and apply fintech innovations (directly or through partnerships) to improve the customer experience, better manage credit risk, increase originations, and improve margins. Critically, fintech is no longer the exclusive province of only the largest banks. There is mounting evidence that the new level of consumer empowerment associated with fintech may be fomenting changes in how the average American prioritizes his or her personal financial obligations. And that may mean new opportunities for community banks stuck behind the curve on the fintech revolution.
Most notably, research has demonstrated that fintechs have led to growth in the availability of credit – but not the kind you might think. According to data from TransUnion, originations of new subprime loans declined for the first time in five years in the second quarter of 2017; however, more individuals now have prime-rated unsecured personal debt than ever before.
A total of 16 million consumers now have a personal line of credit; and both loan balances, as well as the average amount of unsecured debt per borrower, have reached new highs this year.
Contrary to what may be expected, delinquency and default rates on unsecured loans are trending far below traditional norms. Some attribute this to larger loans taken by the most creditworthy consumers. However, research suggests that the secret sauce is the emergence of new financial technology that provides an unprecedented level of insight into consumer credit trends and behavior.
It’s been historically demonstrated that when faced with financial distress individuals tend to prioritize secured lending products, such as auto loans and mortgages, over unsecured credit. But evidence reflects that lending platforms based on complex algorithms appear to be driving more responsible behavior when it comes to unsecured credit by making it easier for borrowers to keep track of and pay off monthly balances and that they are better adept at weeding out good credit from bad.
According to TransUnion, personal loan borrowers may feel they can “get a quick win” with these loans.
“There’s a clear, near-term end to the obligation – a light at the end of the tunnel – that makes it attractive to pay personal loans ahead of longer – term debt like auto loans or mortgages,” the company notes.
Ezra Becker, a research analyst at TransUnion, posits that the relatively short duration of these loans – usually less than 30 months – could be a key factor in the decision process of consumers.
“While personal loans have existed for a long time, recent growth in the number of such loans led us to explore this product’s position along the payment spectrum,” he said. “The prioritization of personal loan payments above all others is counterintuitive, but our study results are clear.”
Other recent reports, including a working paper released in July by The Philadelphia Federal Reserve, suggest that financial technology has helped shine an important light on the more than half of all Americans considered “credit invisible” by using machine learning algorithms to implement customer engagement strategies based on behavioral principles (such as nudges, incentives and rewards) that encourage cardholders to improve their credit by paying off their debt faster and avoiding delinquency.
Using account-level data from Lending Club, the Fed determined that credit-rating grades have a decreasing correlation with FICO scores and debt-to-income ratios, indicating that alternative data is being used and performing well so far.
“An important advantage to Fintech lenders is that they have access to nontraditional data sources that are not used (or not available) to traditional bank lenders, such as FICO scores and DTI ratios,” the Fed report notes. “The additional sources of information include consumers’ payment history (utility, phone, PayPal, Amazon), their medical and insurance claims, their social network, and so forth. These are not factors that are reflected fully in the traditional credit scores.”
The implication is that traditional banking institutions have been hamstrung by a handful of limited metrics that has had the effect of cutting out swaths of potentially creditworthy individuals. We at BancAlliance will be keeping an eye on these trends and encourage readers to review the latest research to see how they too can begin bringing millions of “credit invisible” Americans into the world of personal credit. Technology is changing every industry, including banking. For community banks, those changes may very well be a game-changing opportunity.