Econ_May_05

The Economist

May 5th 2018

FINANCIAL INCLUSION

SPECIAL REPORT

NOONE GETS up in the morning thinking theywant to do

some banking, notes PiyushGupta, boss of

DBS

, South-East

Asia’s biggest bank. Speaking in March at the Money 20/20 con-

ference in Singapore, Mr Gupta meant that banking is just a

means to an end—buying a house, paying school fees and so on.

And in a digital world, banks risk becoming invisible—“dumb

pipes” designed and managed by others. They seem unlikely to

be bigwinners in the newfinancial world.

Theirmain competitors, however, are not the fintechs. Dur-

ing the dotcom boom of the late 1990s, ambitious internet start-

ups saw themselves as revolutionaries. The big financial institu-

tions, so set in theirways, would surelybe swept awayby awave

of internet-based disintermediation. Sure enough, the incum-

bents nearlywent under—but because of the global financial cri-

sis, not competition fromnimbler rivals. Fintechs today aremost-

ly reformists rather than revolutionaries. Thanks to open

Winners and losers

The best of times

Despite some risks, consumers are in clover

(checking) account with a bank. That is one reason why they do

not bother much with lending to those without good credit

scores. Another is that, since the financial crisis—the origins of

which, after all, lay in the subprime market—banks have been

anxious to clean up the quality of their loan assets.

The underbankeddo not lackfinancial options, but are gen-

erally charged exorbitant prices for them, especially when mea-

sured by the annualised percentage interest rate (

APR

). In Britain

such lenders include pawnbrokers, offering an

APR

of between

25% and 101% for a secured loan; doorstep lenders such as Provi-

dent, the biggest, whichwill charge an

APR

of1,558% for a13-week

loan; “payday lenders” such as Wonga, which offer similar rates

for a loan to be repaid after1-35 days in one lump sum; and “rent-

to-own” lenders, such as BrightHouse, which offer finance for

purchases to be repaid in instalments. In America the industry

also includes “check-cashers” that pay immediate cash (at a dis-

count) for cheques that would take days to clear in a bank, and

“title-lenders” that lend against the borrower’s car. In both coun-

tries these fringes of legal finance are the last defences against a

scary, unregulatedworld of illegal loan-sharking.

Prey for them

In both countries, too, this end of the credit market has

caused regulatory concern. Some of the lending is clearly preda-

tory. According to America’s Consumer Financial Protection Bu-

reau, a controversial watchdog set up after the financial crisis, in

2016 more than four-fifths of those who borrowed against their

cars had to renew their loans; a large proportion of these end up

losing their vehicles. And some payday loans seemdesigned not

to be repaid but to go into default, laying the foundations of a

long-term debt relationship. In Britain the regulator, the Finan-

cial Conduct Authority, in 2015 imposed interest caps on payday

lenders, some ofwhichwere charging

APR

s in excess of 5,000%.

But as Lisa Servon, an American academic, finds in her

book “The Unbanking of America”, lenders to the less well-off

are not all purely exploitative, nor are they feared and resented

by all their users. Rather, they are meeting a need unfulfilled by

banks and welfare systems. However, the high cost of their pro-

ducts makes them vulnerable to new entrants to the market.

Fired by a mixture of technological zeal, idealism and the profit

motive, such firms are competing for the unbanked dollar.

As in the developing world, technology can help in three

main ways: by making identity checks easier; by lowering costs;

and by enabling new forms of credit assessment. Auxmoney, a

German online-credit marketplace, allows loan applications to

be submitted entirely digitally and remotely, including an identi-

ty check and digital signature by video link. By automating pro-

cesses and dealing with customers mainly online (usually via a

mobile phone), such operators keep down staff numbers and

costs. Oakam’s boss, Frederic Nze, says that its cost-income ratio

is 50%, and trending downwards to below 40%, compared with

57% for a typical doorstep lender.

Oakam’s rates, which by statute have to be prominently

displayed on its website, are high (“1,421%

APR

representative” in

March). But a group of borrowers at their Dalston branch seem

unbotheredby this.What seems tomatter to themis that theyare

treated decently. One, a rehabilitated drug user and single moth-

er, was so angered by her experience at another lender that she

went out and spent her £100 loan on crack. Another says that no

bankwill touch her because she once splurged on her credit card

when shewas18. All are glad to have access to credit at all.

What Oakam shares with other nonprime lenders, and

those in poor countries, is a willingness to look beyond the

scores handed out by credit bureaus. Those data are backward-

looking, ignore much non-credit history, such as regular pay-

ments to utilities, and have nothing to say about those with little

or no borrowing history (“a thin file”). This often excludes poten-

tially valuable clients: immigrants anxious to build a good repu-

tation in their new homeland; students with bright career pros-

pects; hardworking, trustworthy individuals needing cash to

tide themover a difficult patch. These should not be hard to lend

to. Ken Rees, the boss of Elevate, says he is constantly meeting

people from fintechs advertising their data-processing prowess,

yet on examination they mostly just extend the realms of the

banked to bring in those who, even on a cursory check, would

have been included anyway.

But lenders nowhave wads of other data, too. Oportun, for

example, is an American firmwith 270 physical outlets, with its

roots in the Latino immigrant community. It offers instalment

loans at a typical interest rate of around 32%. One morning in

March at its branch in Redwood City, California, three tellers—all

Spanish-speaking locals who had first come into contact with

Oportun because they or their families had been borrowers—

have just one client between them. His documents—some utility

bills and a bank statement—are scanned and transmitted to head

office. Within minutes, the automated loan approval comes

through. Oportun reports its lending to credit bureaus, helping its

clients build up their histories. Success, says Raul Vazquez, the

chief executive, can be seen as getting them into the formal sys-

tem. So the business model is to get rid of the best customers,

which seems almost perverse.

In rich countries such as Britain and America, where most

people have current accounts, their bank statements offer lend-

ers plenty ofdata that algorithms can feast on. The ability to ana-

lyse thembetter than banks and other rivalsmay provide a com-

petitive edge. But digital technology also provides data through

the apps that users download on their phones. Lenders say they

can learn a lot from how, and how often, their customers use

their app. Oakam, for example, offers an in-app game in which

customers climb a “ladder” of client categories to earn a higher

status and discounts. For people at the bottomofthe credit pile, it

is an apt metaphor.

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