A revolution in lending and credit analysis
October 27, 2015 | by Sanjib Kalita
The financial crisis of 2008 shattered institutions that were the bedrock of finance. Amongst the chaos and uncertainty, banks, the traditional providers of credit and lending, pulled back. Concurrently, the market need for credit increased.
As the market presented new opportunities, professionals who had been at traditional lenders left to start or join new companies. Additionally, financial services companies that hadn’t provided credit saw the opportunity and began offering credit services. Market changes also presented opportunities to use new data and analytical methods.
From bankers to entrepreneurs
One strong example of this movement is MPOWER Financing, an alternative lender that provides loans to students left out of traditional banking options. MPOWER’s CEO and co-founder, Emmanuel Smadja, began his career at Capital One. Several years later, he saw an opportunity to extend credit to an untapped segment of the population: International students at top U.S. institutions.
“Traditional lending is heavily anchored on FICO. FICO is a good metric if you’re looking at someone who’s middle-aged and financially active, because you have years of data to rely on for all the accounts this person holds. Yet, FICO leaves out younger people and falls short when assessing people going through a major life change – like obtaining an advanced degree. At MPOWER, we go beyond the FICO score and look at dozens of academic and professional variables to underwrite undergraduate and graduate students.”
Kevin Brown, VP of Marketing and Product for Credibly, spent more than eight years at Citi. Brown described Credibly as “an emerging fintech platform leveraging data science and technology to serve small and medium businesses to deliver the most affordable and right-sized capital.”
While both Brown and Smadja served credit markets as parts of large banks, leaving these institutions changed their perspectives. According to Smadja, “The biggest change in my perspective of credit since my banking days is that I no longer view credit-worthiness as a historical metric; I look at it as a trajectory. Someone’s credit-worthiness should not only encompass historical data, but also future data.”
From alt payment to alt lending
The growth of alternative lenders attracted the attention of other financial providers.
One of the early disruptors, and now an industry leader in online payments, PayPal, decided to enter the small and medium businesses (SMBs) lending market in 2013. Darrell Esch, VP of SMB Lending for PayPal, commented: “Since the program launched in September of 2013, PayPal Working Capital has provided more than $500 million in capital to more than 40,000 SMBs.”
PayPal’s relationship to SMB customers is a critical piece of the lending business. According to Esch, “PayPal Working Capital is offered exclusively to PayPal business customers with strong PayPal sales histories. Eligibility is based on PayPal sales history, not a business or personal credit score.”
Another payments disruptor in the SMB financing space is Square. Square’s introduction of mobile point-of-sale (POS) systems expanded the types of merchants accepting credit cards by dramatically simplifying the process. Square appears to be having a similar impact with Square Capital.
According to Faryl Ury, product communications head at Square, “With Square Capital there is no application process, and businesses get their money as soon as the next business day. For example: Square might reach out to a business and offer them $10,000, which they’d get as soon as the next business day. In return, Square would get $11,300 of their future card sales.”
It is interesting to note that both PayPal and Square use a deeper understanding of their customers to provide SMB financing with easier processes, faster access to capital and more flexible payment terms.
From rocket science to data science
The increase in types of lenders and borrowing situations has altered perspectives on data and infrastructure that have remained relatively static for decades. The plethora of data and precise calculations needed have pushed credit analytics toward the frontiers of data science, drawing new entrants to the credit space as well.
Nuno Sebastiao, founder & CEO, Feedzai, previously led the development of the European Space Agency Satellite Simulation Infrastructure. This outsider’s perspective helped Nuno create something beyond the industry status quo.
The increase in types of lenders and borrowing situations has altered perspectives on data and infrastructure that have remained relatively static for decades.
According to Nuno, “Most of the world’s data has been created in the last two years, and within this new era of the Internet of Things, the mobile-enabled consumer demands an instant service delivery that is one-click simple. Yet, existing fraud systems were built using technology and science from the 1990s. So we built a risk platform – using artificially intelligent machine learning – that captures big data streams from non-traditional sources.”
While many other new entrants in the alternative lending space have chosen to compete with the established industry, Feedzai has chosen to partner with it in order to improve credit prediction capabilities for the existing market. This strategy can be challenging, especially in a conservative industry such as financial services.
When asked about receptivity by the industry, Nuno responded, “It’s been very positive. Last year we saw a 300-percent year-over-year growth, and our customers include the world’s largest processor, a top-five bank, a top-three acquirer and a top-three telecommunications company, amongst others.”
Disruptions in the credit markets have led to transformations at personal, business and infrastructure levels, and these changes will accelerate.
According to Sebastiao, “We will see the machine-learning science used by Google, Amazon and Netflix become more widely adopted within the financial industry to make the application, underwriting and servicing process easier and safer. Startups like Upstart and Driverup are creating lending marketplaces that rely on non-traditional credit-history data.”
The invention of credit has empowered both businesses and consumers to lead better lives and maintain stability through the waves of life.
New entrants into the lending space will also be able to use existing data and infrastructure in new ways. Smadja cited an example. “One of the companies we admire, LendStreet, uses data from collections agencies to single out the most responsible consumers (those who’ve been making timely payments for several months) and provide them with a fresh financial start and the opportunity to build their credit.”
Perhaps that is a key transformation and an opportunity to build or rebuild credit through collaboration. The invention of credit has empowered both businesses and consumers to lead better lives and maintain stability through the waves of life.