Fintech Lecture 6: Credit and Lending
Credit is what comes in and debit is what goes out.
Q. How are big tech companies strategically positioning themselves in lending?
Big techs are doing well in this space because they already have a network of users and data, so creating a credit or lending solution should be a seamless experience. For example Apple credit card, Amazon pay and Alipay.
They know both sides of the market as they have created a marketplace of their own. They know the transaction of its sellers and can create underwriting models. Because sellers are of small or medium size, the lending will be small, which can be labeled as Microlending, makes repayment easy.
So that data, order flow, and that activity give them a natural competitive edge. They can see merchant’s payment stream, but also, can lower the credit risk because consumers are buying their products. You take your piece to pay back, whether it’s a revolving or term loan to a merchant.
EMIs are lending money for a certain period of time.
Actually, Alipay has its own credit rating. They can determine how much money you can borrow from Alibaba.
Marketplace Lending
It is the concept of allowing individuals to lend to other individuals or companies through a marketplace. While they’ve been around for a while, they’ve really just come into lending platforms and they’re really supported by a securitization market behind them, rather than individuals lending on the platform for the most part.
The idea was to keep it peer to peer, without a central intermediary. Now, there was always going to be some intermediary. Because there was a platform, a software provider taking a fee, but somehow matching lenders to borrowers in a peer-to-peer network was difficult. So it is shifted from peer to peer to Online portals.
What we found over these 13 or 15 years is that the marketplace lenders like LendingClub have shifted to securitization market to raise their money, a highly organized and somewhat centralized securitization market and on the lending side, we are going through a portal and that there’s only so many of these portals.
So it’s not that it’s truly peer-to-peer and in fact, often it’s now called marketplace lending in its platforms. I think that it’s still a crucial part of the disruptive credit landscape, but it’s a small percentage of that marketplace and it’s shifting very dramatically from peer to peer to online portals. It still accesses centralized credit in many ways.
Credit Sector
We’ve already seen big techs in payment, the Payment Unicorns. There are hundreds of other payment companies that are building credit on top of payment and sometimes a payment company is really also a credit company.
Credit sector is straightforward, household or corporate. But if you’re thinking about disrupting this space, you would think, all right, where am I going to slice into? Am I going to try to do something in mortgages, or credit cards? Am I going to try to go to the high end, the low credit risk super prime? Or am I going to try to be in the sub-prime marketplace?
There are startups who started their luck in corporate lending, with the business side — small, medium-sized enterprise lending. There’s no really good definition of SMEs but the definition that these companies would take at it that these are companies that are having difficulty borrowing from the big banks. It’s either assessing credit or providing that credit in a timely and cost-effective way.
But large enterprises can access the securities markets directly. Large enterprises are, by and large, borrowing from big banks or securities markets.
In the credit and lending sector, everybody had the same access, Equal Credit Opportunity Act, that you can not differentiate because of gender, race, or nationality and Fair Credit Reporting.
Well, now, fast forward to 2021. How can we protect that we still have equal credit and that it’s explainable? And why is somebody turned down? And once somebody is not allowed to take credit, it gets tougher with AI/ML. It also gets tougher when there’s not a physical location.
And thirdly, many of these companies are not regulated or registered as banks and regulators around the globe tended to look at banks to make sure that these laws were fairly applied. Now, they also look to the credit reporting agencies. So I think the real answer is in these changing times, the official sector around the globe has to adapt and sometimes change a little bit of who is regulated and even if you’re a non-bank, that you still have to comply with some of these things.
Now, in the US, we’ve got about $14 trillion of household debt. Before the corona crisis, US was a $22 trillion economy and so you could see it’s about 2/3 of the economy, is the underlying consumer household debt. The corporate sector — very important as well. But it’s the household sector dominated in the US by mortgages — 2/3 of that or about $10 trillion, $11 trillion of the mortgage market.
Credit and Lending
Large incumbents sometimes don’t feel that they can, assess the credit and reach the distribution to small businesses in a cost-effective way and then the disruptive companies say, we could provide.
If you look at a company and supplier base, you’ll see that 80/20 rule applies fairly well. So the top 20 suppliers are generally supplying the majority of their inventory. Purchasing on that bottom tail of the suppliers are all very small businesses. They’re hard to lend to and do all the KYC requirements, which is really what big banks do not like doing. So a startup could come in there, partner with a corporate bank, and lend to or extend credit to a supplier.
In US credit card system, American Express, Discover, and Cap One control 80%, as of last year credit card business.
Credit cards have a very different risk profile. This is about a little over $1 trillion asset class market in the US. But 22% are smaller providers. Can startups chip away this 22%? Yes, they can, by using alternative data. But the big banks are not asleep. They’re not ignoring alternative data.
A new startup can approach this in a different way and particularly provide a better user interface. Here in the US, what’s happening is rather than credit card products, they’re providing personal loans. The yellow ones in the below image are not banks. They are small loan providers.
A personal loan is not tied to a credit card. It’s usually an installment or term loan. But you can see the shift just in these five years, that the disruptors are eating into the market share in this space.
Over 92% of student loans in America are either guaranteed or direct loans from the Department of Education.
But of course, the private loan market where graduate students and particularly those who are not US citizens are more likely in the private student loan market. These are probably familiar names to shop for a student loan or a traditional bank like SunTrust and Wells Fargo and that 8% of that market is still about $100-plus billion.
The overall student loan market is $1.6 trillion. Marketplace lending is an online platform connecting borrowers and investors. So it’s a platform in the middle, started with this concept of being peer to peer.
LendingClub is one of those examples. The investors on the other side of LendingClub are often hedge funds and asset managers are saying we can invest. LendingClub is providing us a portfolio of loans and you can see the numbers here,16-month average duration, and 1.6 to 7 .5% range of returns.
Facebook Libra (Optional)
Facebook Libra had announced in June of 2019 and then the People’s Bank of China had already been working on the digital currency project. But then they sped that up a bit and announced within a month or two that they were going to move forward with their currency project.
Libra had announced a token pegged to 4–5 other currencies, so it is a multicurrency basket. There was a lot of push-back from central banks around the globe on this concept that they would create what Facebook actually announced — a global currency for billions of people.
There was concern amongst the G7 and G20 countries, but there was also a concern of a broader group of developing countries as well, as to what this meant for their monetary policy, how stable this would really be, and whether it would compete with fiat currencies, not in a positive way.
Libra 1.0 was supposed to be a multi-currency token but in 2.0 they have introduced multiple single currency tokens to give those currencies a digital form. They are only going to work with digital wallets and crypto exchanges in certain jurisdictions which are registered and following anti-money laundering law.
They have said additionally, we’ll embed in the software some protocols, to guard against sanction and some other things. Will this be enough to satisfy the official sector? Yet to be seen. They are going to start with Switzerland.
Facebook libra is promoting themselves as a new form of standard Dollar and Euro, to the countries for regularization which will have an instant settlement or continuous real-time payment system. There are challenges, but Libra is not stopping. Facebook is now used to these regulation-related calls. They do not have a good reputation when it comes to working with user data and now that when they are going to handle their money, they have to build trust and face more heat. But I’m sure these things won’t stop their ambitious project.
Lecture 5 — Payment —- — — — Lecture 7 — Challenger Banks
Lecture 1 — Introduction — — — — — — — — — — — Index
