09.29.2017
By Rob Daly

OPINION: Fintech’s Dirty Little Secret

Why does it seem that there are more startups in the finance space than any time before? The secret is that like nature, Wall Street abhors a vacuum.

Ever since the 2008 credit implosion, the financial market has been broken. Driven by the regulations geared to deleverage bank balance sheets, banks have become much more risk-averse than any time in modern memory.

Most of the largest banks have trimmed their client lists to those customers that pose the least risk. As someone who works in the credit division of a tier-1 bank put it: “Everyone remembers which business you brought in.”

As a result, vast swaths of potential credit customers remain frozen out of the credit market, especially in the retail market.

Roughly half of the population in the US have a FICO credit score that is less than 650, according to Sasha Orloff, CEO of online lending startup LendUp, during the Finance Disrupted conference hosted by The Economist in Midtown Manhattan. “That means nearly half of people cannot get credit from banks today,” he said.

When there is such a disruption, leave it to capitalism to find ways to deliver services to those without access to them. PayPal, Kabbage, LendUp, Square, and other online lenders have stepped in to fill the gap.

According to PayPal CEO Dan Schulman, who also spoke at the conference, of the $3 billion PayPal has loaned, 25% of it has been in the 3% of US countries where more than ten banks have closed branches.

More interesting is that these startups do not use an applicant’s FICO score in determining whether to lend or not. Instead, they examine other data and compare it to the applicant’s peer group.

Given the rise of big data and the volumes of work and spending histories available, many of the startups argue that they have a better understanding of their clients.

The same trend is occurring in the asset management space as well where robo advisers are making it easier to service the client segment that in the past would only warrant an annual phone call.

However, many robo advisers just are putting a new technology wrapper on a tried and true business model, according to Walter Bettinger, president and CEO of Charles Schwab and who also spoke at the conference.

“What they do is take a risk profile and make allocations based on that in relatively low-cost underlying instruments, rebalance the portfolio, and do some level of tax harvesting,” he said. “That’s been going on for decades.”

On the bright side for the entrenched players, the initial wave of fintech startups deciding to “go it alone” has come to an end, according to a consensus of the conference speakers. Most fintech startups look to partner with banks rather than compete with them.

As the financial market continues to heal itself, expect more innovative business models to pop up.

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