In this lecture, we're going to talk about FinTech credit and some of the factors that have led to an increase in demand for FinTech credit products. As well as the factors that are driving new FinTech credit firms to enter the market. I'd like to begin by offering a definition. FinTech credit encompasses all credit activity facilitated by electronic platforms, whereby borrowers are matched directly with lenders. FinTech credit is also referred to as loan-based crowdfunding, peer-to-peer lending, or marketplace lending. Whenever one of these terms is used, its typically referring to the same thing. Mainly, some type of FinTech credit provision. These electronic platforms can facilitate a range of credit obligations. Including secured and unsecured lending to both businesses and consumers. As well as non-loan debt funding, such as invoice financing, which is simply a way for businesses to borrow money against the amounts due to that from customers. These electronic platforms can go be on a peer-to-peer matching business model, by using their own balance sheet to fund loans that they make and then keeping these loans on their balance sheet. Now, let's take a look at some of the factors that are driving the supply of new FinTech credit providers and credit products. The most important factor is that FinTech lenders are able to make more intensive and efficient use of new digital innovations. They've been able to essentially automate the entire lending process, with provides consumers with a convenient and quick service. In addition, FinTech lenders have been able to make use of new non-traditional data sources. To assess borrower credit risk, banks have traditionally relied on metrics like credit scores, as well as debt and income levels. However, FinTech lenders are able to incorporate additional data elements, such as a business' sales volume on Amazon or eBay, or customer reviews from websites like Yelp. For assessing an individual's credit risk, FinTech lenders may incorporate data from social media profiles. Combined with traditional metrics, these additional data points may provide FinTech lenders with a more complete credit risk profile for each prospective borrower. Here we have a chart that demonstrates the difference between banks and FinTech lenders credit scoring methodology. It comes to us courtesy of online lender Lending Club and attracts the correlation over time between a borrowers FICO score, commonly referred to as your credit score, and the rating that Lending Club assigned to the borrower using their proprietary algorithm. Which looks beyond FICO scores to estimate the likelihood of default. We can see that in lending clubs' early days in 2007, the correlation between the two was fairly high, at around 80%. But as time has gone on, and Lending Club has incorporated additional data points into their algorithm, the correlation has gone down quite significantly. To the point where in 2015, The correlation between a borrowers' FICO score and the great assigned to them by Lending Club was a little over 35%. To me, this indicates that FinTech lenders like Lending Club continue to incorporate additional information into their credit scoring methodology, which is resulting in different borrower credit risk profiles, and what a traditional bank would come up with. This holds the potential for borrowers who can't get access to credit from traditional banks, because they have poor or not existing credit scores. To get credit from FinTech lenders, who are willing and able to look beyond the traditional credit score. Another factor that's influencing the supply FinTech credit is the ease with which FinTech lenders are able to scale. Once they've built the platform, the costs associated with acquiring the next customer is relatively low. Because everything is done digitally and online, FinTech lenders can reach a broad customer base. And remember that the lending process is automated, so there's really not a lot of human intervention that goes into it, which also allows these FinTech lenders to grow quickly. FinTech lenders also enjoy cost advantages over traditional lenders. FinTech lenders don't have brick and mortar branches to pay for. And they're not wedded to legacy IT systems that are often costly to maintain. In addition, because most FinTech lenders are not Banks and therefore not subject to the supervision by federal banking agencies, they don't have to hold as much capital and liquidity as do banks and their overall regulatory compliance costs are lower. The final factor that's driving the supply of new FinTech credit providers is that after the financial crisis, traditional lenders withdrew from certain market segments. Either because they suffered heavy losses in these markets, or because new rules and regulations imposed after the crisis made it no longer profitable to serve the segments and this created an opportunity for FinTech lenders to step in, and fill that void. It is this potential for FinTech lenders to expand access to credit for under-served populations that has generated a lot of excitement about the industry. Particularly among-st policymakers. Small businesses are one of the groups that have experienced difficulty in obtaining credit in the wake of the financial crisis. While bank loans to bigger corporations have recovered since the recession, as we can see in this chart, small business lending still hasn't caught up with levels from before the financial crisis. This is in part because banks suffered particularly heavy losses on small business loans during the recession, and remain wary of the sector. In addition, the cost of underwriting such loans can be prohibited because of the time required for data collection and verification on what are often relatively small loan amounts. New online FinTech lenders with their emphasis on automation are helping to speed up the process and cut these cost. This is why many new FinTech lenders target small businesses exclusively. Let's now discuss several factors that are influencing the demand for FinTech credit products, starting with consumer tastes and preferences. Nowadays, consumers expect a user friendly experience as well as something that is convenient, fast and cost-effective and this is something that FinTech lenders have thus far been successful at. Changing demographic factors are also influencing the demand for FinTech credit products. There's an entire generation of young people, known as digital natives that has spent their entire lives with access to the internet or mobile devices, and have become accustomed to doing everything online including their banking. In addition, Consumers in many emerging markets have rapidly adopted new digital technologies. And these countries may not have a well established banking system, which creates an opportunity for FinTech credit providers to gain access to new customers with few competitors standing in their way. Another factor influencing the demand for FinTech credit products is the decline in consumer trust in traditional lenders in the aftermath of the financial crisis. There may be a more general perception among some consumers, particularly young consumers that FinTech lenders are more socially responsible and have greater social value than conventional banks and therefore they're more willing to engage with FinTech lenders. The final factor influencing the demand for FinTech credit is the willingness of investors to purchase a loans generated by FinTech credit platforms. Without investors, FinTech lenders cannot make loans because these lenders do not have enough capital to hold the loans on their own balance sheet. In the wake of the financial crisis, the Federal Reserve push interest rates to near zero, which lowered the returns investors were earning on traditional fixed income assets, like corporate bonds. Tired of these low returns, many investors starting purchasing the loans being generated by FinTech credit platforms, because they offer higher returns. This provided a boost to the nascent FinTech credit industry. But now that interest rates are starting to go up, many are wondering if investor appetite for FinTech loans will decline.
