It’s not the kind of loan the big banks make anymore. Donald Allen needed about $35,000 to expand his catering business. So on the advice of his son, a business school graduate who knows more about these things, Allen didn’t go to the bank in Salisbury, North Carolina. He went online to a financial technology company called LendingClub, which connected Allen to the nonprofit community development lender Opportunity Fund. Within five business days, he was approved. “It was easy,” Allen says. He could get on with acquiring a food storage truck and adding two employees so he could better serve area homebuilders who wanted food at their open houses.
Since the financial crisis and the new regulatory strictures introduced by the 2010 Dodd-Frank law, banks are more reluctant to make small loans, especially risky ones. Underserved communities and individuals with blemished credit scores have been particularly hard-hit. Minority-owned businesses like Allen’s are increasingly turning to fintech companies with their new lending models, but the lightly regulated field opens the door to exploitation — and has advocates pushing for tougher federal protections. “What we see is the predatory nature of a lot of these companies, and they are definitely looking at how they can avoid or evade state law,” Beverly Brown Ruggia, financial justice organizer for New Jersey Citizen Action, said in a recent forum at the progressive Netroots Nation conference in Atlanta.
"THERE’S A LOT YOU CAN DO TO OUTPERFORM FICO WHILE NOT DOING ANYTHING CRAZY LIKE DUMPING FACEBOOK STUFF INTO A MACHINE-LEARNING MODEL."
A 2015 survey conducted by Federal Reserve banks confirms that smaller and minority-owned businesses face an uphill battle for access to credit. It noted that only 29 percent of credit applications from very small businesses (with no employees other than the owners) received the full requested loan amount, while 30 percent received partial funding. This year a Federal Reserve analysis of data from the LendingClub marketplace found that the fintech newcomer is penetrating potentially underserved areas that have lost bank branches. The report also concluded that LendingClub’s risk assessments had little correlation with the standard FICO scores, which “suggests that the traditional credit scores may have been discriminatory.”
Fintech firms can use big data to reach into potential borrowers’ medical and insurance claims, accounts like PayPal and Amazon and even social media — such as Yelp reviews of the business. It’s all done to build a better assessment of default risk, to decide whether to give a loan and to adjust the interest rate accordingly. Louis Caditz-Peck, director of public policy for LendingClub, tells OZY the company does a deep dive into a potential borrower’s financial life and other characteristics, while protecting borrowers’ legal rights against, say, racial profiling. “There’s a lot you can do to outperform FICO while not doing anything crazy like dumping Facebook stuff into a machine-learning model,” he says. The technology allows a quicker risk assessment and fraud screening.
The model is sort of like an Airbnb for loans, as LendingClub serves as a platform to connect lenders with borrowers for personal, auto and business financing. Like many of its Silicon Valley brethren, it has evaded the regulations that surround existing market players. The oversight reach of the Consumer Financial Protection Bureau includes fintech companies, but it generally cracks down on companies after it fields complaints about them — nothing like the regular Federal Deposit Insurance Corp. scrutiny of banks. Some states set a legal limit to the interest rates lenders are allowed to charge, but online companies can make enforcement difficult.
Witness the case of CashCall, a payday lender that a judge ruled had a sham relationship with a tribal company called Western Sky Financial to charge exorbitant interest rates that broke the law in 16 states. The scheme went on for years before the CFPB filed suit. (President Donald Trump has proposed restructuring the CFPB, and many Republicans in Congress want to eliminate it.) LendingClub, a leader in the field that does not charge exorbitant rates, has faced controversy of its own. The company sacked its founding CEO last year after problems with lending practices and his own personal investments surfaced.
The advocates at the Netroots conference in Atlanta spoke of the plight of minority borrowers, but while fintech has some promise, there is no easy solution. Mitria Wilson, a former Capitol Hill aide who now works for the Center for Global Policy Solutions, pointed out that fintech companies mostly serve prime customers such as those known in the industry as HENRYs — high earning, not rich yet. Paulina Gonzalez, executive director of the California Reinvestment Coalition, said proprietary algorithms raise transparency concerns, and only big banks have the scale and resources to tip the scales in serving low-income or minority borrowers. “Every time I go to a conference on fintech, somebody on that panel says fintech is going to be the magic wand that brings these loans back to these communities,” Gonzalez said. “When I ask the question, ‘How?’ nobody can give me that answer.”
LendingClub does not take all comers, but its novel partnership with Opportunity Fund, which has been around for more than 20 years in California, now can reach a broader market. A joint algorithm may find borrowers like Allen, the caterer in North Carolina, too risky for LendingClub, but they meet the criteria of Opportunity Fund, so they are instantly qualified for a three-year loan. The alternative is the pricey world of short-term lending. Marco Lucioni, executive vice president of lending for Opportunity Fund, says Allen most likely would have paid 30 or 40 percentage points more on a series of short-term loans — with payments costing $5,000 to $6,000 more over the life of the loan. Instead, Allen can spend that money on grilling up more steaks and ribs.
