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Imagine a subprime consumer who wants to pay his credit card bills because his interest rates hover between 15% and 21%. They want to take out a personal loan with better repayment plans to pay off their existing debt.

Are people more likely to go to a bank or credit union when researching their options, or will they be more intrigued by fintech offering loans entirely online?

The latter seems to be a nicer option. And that’s what happened. Fintechs have wrested market share left and right from traditional banks and credit unions. FinTech claimed 49.4% of the unsecured personal loan market in March 2019, up from 22.4% four years earlier, according to Experian.

The level of delinquencies, however, is much higher on these non-traditional loans, with fintechs reporting a delinquency rate of 3.53% 15 months after the loans were granted, nearly double the provider rate. traditional 1.77%, according to a recent study of two companies. school teachers.

( Dig deeper: Fintech lenders will come back in force as the economy reopens )

The study – “Fintech borrowers: lax filtering or skimming– led by Marco Di Maggio of Harvard Business School and Vincent Yao of Georgia State University, was first published in 2018 and updated in late 2020. What they found is not a pretty sight. for fintech lenders.

On the one hand, the co-authors found that borrowers with high interest rates on their fintech loans are almost 40% more likely to be in delinquency, and their credit scores decline more than a bank loan. or credit union – an average decrease of 12 points instead of 0.9 points. – and their total debt increases by more than $ 8,000 after just one year.

According to Di Maggio and Yao, fintechs could target target audiences with risky credit scores and poor credit histories, as they recognize that these consumers cannot get comparable loans from a traditional banking provider. However, there is not yet enough data to support the theory that these non-bank lenders are actively marketing to at-risk consumers.

It is not exclusively an American problem. Major fintechs in India reported doubling delinquency rate between August 2019 and 2020, according to a report from TransUnion CIBIL.

“The delinquency picture is complicated and will take time to emerge due to the lagged effect of financial conditions, aid programs supported by lenders and changes in payment priorities” of Indian consumers, the report adds. of TransUnion.

Di Maggio and Yao got their data from a credit bureau that provided them with information on unsecured personal loans – a fintech favorite. The two examined a sample of over 200 million consumer credit records and rated borrowers by gender, age, marital status, and college degree, in addition to whether consumers were borrowing from a traditional provider or from a bank. a fintech.

Di Maggio says he cannot disclose which credit bureau he worked with to extract data on fintech default rates. The data – provided to Di Maggio as anonymous consumers – allowed the authors to match people with different types of loans and determine which loans came from which type of lender.

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Data that made waves

To dig deeper into the paper, The financial brand spoke to Di Maggio who said he decided to pursue the topic when he realized a profound lack of information on fintech default rates.

“I researched academic literature, looked at it [and found] it was sort of a difficult question to deal with, ”he explains, adding that it is not common or easy to find the data to back up what he and his coauthor have speculated. It’s still a fairly new conversation and the data isn’t plentiful yet, even though fintech lending is taking up space in the lending market exponentially.

Di Maggio mainly focuses on personal fintech loans, which are mainly used for the consolidation of existing debts. He sees it as the “riskiest segment” because, although borrowers may use part of personal loans to pay their unpaid bills, not all funds always go towards the intended purpose.

The vicious circle :

People only use part of the debt consolidation loan they have taken out to pay off their debts. Instead, they use a large portion of the loan to make new purchases.

And the problem has grown dramatically, he says, because people with card debt often keep the cards after paying them off and then increase the balance again.

“The worst outcome happens because if $ 40,000 wasn’t viable before, you now end up six months later with $ 80,000,” said Di Maggio. “In addition, borrowers’ results worsen in the months following the origination of the fintech loan compared to similar people borrowing from non-fintech lenders.” This is a classic weak point of debt consolidation loans. FinTechs have just made the process a lot easier.

Di Maggio’s discoveries are still making waves in the financial sector. When he first presented his research at a conference with a fintech audience, people were angry.

“We’ve had people from LendingClub, people from TransUnion that are very upset,” he says, joking that he challenged them to find data to prove he was wrong. Two years later, he says they have yet to provide him with alternative data.

It’s not all sun and roses

Fintech loans of course have their advantages, which could explain why so many consumers are moving away from conventional providers. People can get loans more easily if they have subprime credit scores, and fintech lenders will look at other forms of personal data to meet creditworthiness requirements.

( Read more: Banks play with dumping credit scores in lending decisions )

There is also much less oversight. While banking regulators threaten to incriminate banks and credit unions for breaches of compliance, fintechs have no federal oversight, although the Consumer Financial Protection Bureau does oversee some practices.

“Some observers argue that fintech lenders might be able to operate where banks don’t find it profitable,” Di Maggio and his co-author wrote in the paper, noting that fintech lenders also have lower fixed costs. to those of traditional lenders, as non-bank institutions do not have branches.

And these advantages are not lost on the attention of traditional banking providers. Banks and credit unions, while unwilling to admit it publicly, are increasingly concerned about the growing swarm of competitors.

They could win on you:

Nearly nine in ten financial institutions are also concerned that fintech loans will exceed their own loans, according to PWC.

It can then be a relief for existing providers to know that they may not have to worry as much as they think. According to Di Maggio and Yao, fintech loans may not be all they claim to be and traditional banking providers still have an edge over challengers. They have a better track record of attracting consumers who can repay their debt. And regulations once supposed to hamper traditional banking providers may be what saves them.

“I think digital lending and banking are less of a threat than, say, what’s happening to the payment system,” maintains Di Maggio, citing Stripe and a similar digital payment specialist, which he says pose a risk. significantly higher for banks than LendingClub.

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