Lending (Capital) in the Twenty-First Century


[Editor’s note: This is a guest post from Rodolfo Gonzalez, an associate at Foundation Capital. Foundation Capital is a bronze sponsor and will be in attendance at LendIt USA 2015 on April 13-15. In this post, he talks about lending capital in the twenty-first century.]FoundationCapital_blog_image

Finance seems too big. Certainly, some banks are too big to fail. But what if finance isn’t big enough yet? Financial services are highly concentrated. Much like the wealthiest 1% of households control 20% of income here in the United States, the distribution of consumer financial services can be viewed in the same way — but on a global scale.

Right now only 50% of people worldwide have access to a savings account and just 20% have access to a loan product from a financial institution. Roughly five billion people that banks don’t serve today. More than anything, finance is poorly distributed.

It’s staggering to think how one of the oldest, most powerful, farthest reaching industries still avoids four fifths of humankind. In other words, banks haven’t figured out how to make money from lending to those other 5 billion people (while still alienating plenty of their actual customers). Last year, in our white paper, we predicted that new marketplace lending platforms would originate $1 trillion in loans within the decade — but what if its potential is even larger? Lending holds the highest transformative potential for those excluded from banking. After all, it is through credit that money is created in the modern economy.

Data and new technologies are the key to unlock credit globally

In the US, the ability to open a bank account, get a credit card, or get a loan to start building a life or business all hinges upon the approval of credit bureau data. Lending Club has built a multibillion-dollar business by accurately pricing the risk of borrowers that were overcharged by credit card operators. And emerging lending platforms are finding new ways to bypass and best FICO – the ‘gold standard’ of credit bureaus. In the developed world, banks have been sitting on (and not utilizing) a wealth of data available that would improve their credit decisions. Banks need to get smarter just to catch up with the underwriting capabilities of new marketplace lending platforms. The data problem also hurts non-bank lenders. At the lower end of the spectrum, most payday lenders refuse to report to bureaus the repayment history of their clients, as they fear graduating them into lower interest loans.

Across the world, the challenge is that most countries have no credit bureaus, and of those who have them, they only report negative payment behavior (as opposed to also including positive and negative behavior and a numerical score). Even then, coverage is patchy, as most of the population is not even listed in the credit bureau databases. Most utility and bill payments are not captured or reported. Moreover, they still carry a lot of the data collection by hand.

Underwriting based on behavioral data, using machine learning and other advanced statistical techniques, will provide the scalability required for banks to offer more to those now without access. Mobile phones are making most of the world’s people accessible electronically for the first time, and provide a wealth of data that a stale stack of stamped bill receipts simply can’t compare with. Unless banks and traditional lenders think of themselves primarily as data and technology companies, they will become increasingly irrelevant.

There are great opportunities ahead, and a new notion of identity can emerge using new technologies. The Bitcoin blockchain holds enormous potential here. I won’t get into the weeds of Bitcoin, but given the distributed nature of the blockchain, the emergence of a decentralized credit bureau with global reach is now a real possibility. Using the blockchain ledger to create a global repository of the world’s credit transactions will establish a new way to assess underwriting and risk with data that was previously unavailable. The notion of a thin-file or no-file borrower can become irrelevant – people will have full, instant access to their complete credit history, and make use of it to access loans in any country, regardless of how long the borrower has been there.

Lowering costs

Every day most Americans swipe their credit cards for groceries, utility bills, or a night out on the town. Charges are applied — merchants pay roughly 30 cents plus 3% of the value of the transaction — and while expensive, merchants oblige because of the convenience credit cards offer to their customers. But imagine that you are a merchant who is also a part of the 3 billion people (50% of the world’s population) living on less than $2.50 a day. That 30 cents credit card fixed fee just does not add up. Who would pay a third of their income (and often half of their margin) just to swipe a card?

I believe Bitcoin – the P2P cryptocurrency – holds the most potential to bring the cost of payments transactions down. Anyone can send 1000s of bitcoins across the world just as easily as sending one hundredth of a million bitcoin, without incurring transaction or remittance fees. Talk about reducing the costs of moving money around.

Most of the costs of holding and moving small balances will be stripped out of such a system (eventually including Deposit Insurance). Electronic delivery and instant disbursement of funds will take place via mobile phone. Non-banks, all while still turning a profit and serving more clients, will perform many of the banks’ functions better. One really wonders what banks will use their branches for 20 years from now!

Change is coming, passed a bank near you

The current banking system is not equipped to carry the task. They use mostly centralized legacy technology infrastructure, and rely heavily on expensive branches and manual processes. Moreover, given their role in the recent financial crisis, they will keep facing increasing capital and regulatory constraints. Banks will continue to pull from lending to ‘risky’ clients. Given their high cost base, banks can’t afford to underwrite and lend money in small amounts as is often requested.

The key to making finance as big and distributed as it should be is held by new marketplace lending platforms. Embracing new data sources, and using cost reducing and feature-enabling technologies like Bitcoin, is where the next mass scale opportunities will be unlocked. Lending in the twenty-first century comes with the promise of transforming the world. The addressable market is immense – 5 billion people strong. There are plenty of loans yet to be made, and one trillion of them might just be the beginning.

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