Making Loans Cheaper and Better?
Automated lending threatens to eat banks for lunch, or so asserts an analysis by Reuters this morning once again reporting on the potential use of automation and Big Data to revolutionize the lending process. The article highlights a young entrepreneur who, after being turned down for a loan by Wells Fargo, was able to secure a $19,000 line of credit from online lender Kabbage, albeit at a much higher interest rate than he would have gotten from a credit union or bank.
The founder of Kabbage explains that he can make underwriting decisions based on Facebook data that is as effective as using a credit score. The confluence of technology, Big Data and Silicon-valley entrepreneurship is already having a profound impact on lending. In Russia, banks are experimenting with making a business loan as easy as going to an ATM. So, don’t get me wrong, any lender who isn’t paying attention to these trends and re-examining existing practices is not, in my ever so humble opinion, exercising appropriate due diligence. But whether this technology represents a wholesale transformation of traditional lending or will ultimately represent the latest failed attempt by non-traditional lenders to ignore erstwhile lending standards remains to be seen.
Most importantly, as Jaime Diamond has pointed out, these non-traditional lenders haven’t been tested in an economic downturn. As we learned from the mortgage meltdown, it’s easy to look like an economic genius when the economy is growing, the real test is how much money you have left when the good times end. Secondly, once the novelty of these lending arrangements wear off, I wonder if what we will be left with is a version of payday loans for entrepreneurs.
In the short to medium term, anyway, you can still get cheaper business loans from a credit union than you can from places like Kabage. Finally, Silicon Valley acts as if banking has been in the technological dark ages. In fact, one of the things that surprised me most about the industry since I dove into it about eight years ago is how technologically savvy it already is. I think the vast majority of consumers would be surprised to find out that their mortgages and loans were approved by an automated underwriting system. As a result, financial institutions are not quite as backward as the Silicon Valley startups suggest.
One of the key challenges facing companies today is to figure out what changes are so transformative that they make a traditional business model obsolete (e.g. iTunes and the record industry) or simply disruptive (i.e. debit cards). No doubt technology is disrupting traditional lending models, but whether it is making them obsolete is far from certain.
See you at the Sagamore!