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The fintech sector continues steaming full speed ahead. It has been calculated that it brings traditional banks almost half their income. According to a study by the consulting company Axis Corporate and the European banking association EFMA, 73% of the companies dedicated to technology-based financial services target personal banking and small companies, and are eating into the banks’ most profitable services.
The fundamental difference between traditional banking and companies in the fintech sector is that banks still have processes and hierarchies that undermine their agility, whereas fintech companies are more agile and cheaper, but have less experience and fewer customers.
Although there’s no doubt that the fintech sector has a great future ahead, it would be well advised to look to the past to learn some of the lessons traditional banks can teach:
There is a belief among online companies in general and technology-based lenders in particular that the goal is always to say yes. If a user needs money, more importance is placed on the customer’s experience and how long the lender will take to access their funds than on analyzing whether that person or business represents a good credit risk.
These companies offer innovative services that seek to access important niches in the credit market. They allow people that have historically been turned down by banks when seeking loans to extend their businesses or pay off their card debts to obtain credit at a lower rate. This is a point where technology lenders can learn from the history of banking, and consider the option of saying no.
Credit grows extremely fast in good times. But it contracts so suddenly that if an institution is not prepared, it may be overwhelmed.
History has repeatedly shown that lenders become overconfident when the economy is booming, convincing themselves and their customers that this time is different.
Warren Buffett, the third richest man in the world in 2018 according to the list compiled by Forbes magazine (after Bill Gates and Amazon’s founder Jeff Bezos), and considered one of the world’s greatest investors, in addition to being the majority shareholder and CEO of Berkshire Hathaway, has spoken specifically about this issue. He refers to it as the institutional imperative, defined as “the tendency of executives to mindlessly imitate the behavior of their peers”. Buffett wrote this in the early 1990s, just when the credit cycle was collapsing for a whole generation of lenders who had convinced themselves that credit risk was a thing of the past.
Different trends have emerged throughout history. In the 1980s for example, investment managers believed that so-called “portfolio insurance” had eradicated the risk inherent in holding shares. The naivety of this view only became clear when they realized that portfolio insurance had accelerated the market crash of October 19, 1987, a day which came to be remembered as Black Monday.
History and the precedents in the financial world are the reason why top bankers are obsessed with risk, and are guarded in their dealings with the credit cycle. “No one has the right to not assume that the business cycle will turn“, warned Jamie Dimon of JPMorgan Chase on the eve of the latest crisis.
Although the modern credit system was created in the 1950s, and since then both the world and technology have come a long way, credit itself has remained the same.
Technology can help in the process of taking out a loan, but it’s not a panacea that renders credit risk obsolete.
However ZestFinance, for example, believes that solvency assessment has been fundamentally transformed by technology. ZestFinance is based on several mathematical decision-making models. While many creditors take hours or even days to make credit decisions, ZestFinance does it in less than ten seconds. Will it turn out to be a good idea for this company to leave the assessment in the hands of technology? We’ll soon find out the answer.
In short, although it’s tempting to dismiss as old-fashioned the hundreds of years of experience gathered from the history of banking, fintech lenders do so at their own risk. This is why it’s advisable for new companies to learn from history and the precedents in their sector, in exactly the same way the banks learn from and create partnerships with fintech companies to improve the customer experience and streamline their own processes.
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