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Financial inclusion in the rich world


(Reposted from The Economist.)

Tech and data offer hope of more financial inclusion in developed countries, too

Britain is not the only rich country where big chunks of the population live largely outside the mainstream financial system. In America the Centre for the New Middle Class, the think-tank arm of Elevate, a Texas-based online lender specialising in the “nonprime” market (not immediately creditworthy), estimates that 109m Americans are nonprime and a further 53m are “credit invisibles”, without enough of a financial history to be assigned a credit score. A survey by the Federal Reserve last year found that 44% of Americans would struggle to meet an unexpected expense of $400 without selling something or borrowing.
Banks make good money out of the way many people with bank accounts and a decent credit standing raise funds at short notice: using a credit card or dipping into the red on a current (checking) account with a bank. That is one reason why they do not bother much with lending to those without good credit scores. Another is that, since the financial crisis—the origins of which, after all, lay in the subprime market—banks have been anxious to clean up the quality of their loan assets.

The underbanked do not lack financial options, but are generally charged exorbitant prices for them, especially when measured by the annualised percentage interest rate (APR). In Britain such lenders include pawnbrokers, offering an APR of between 25% and 101% for a secured loan; doorstep lenders such as Provident, the biggest, which will charge an APR of 1,558% for a 13-week loan; “payday lenders” such as Wonga, which offer similar rates for a loan to be repaid after 1-35 days in one lump sum; and “rent-to-own” lenders, such as BrightHouse, which offer finance for purchases to be repaid in instalments. In America the industry also includes “check-cashers” that pay immediate cash (at a discount) for cheques that would take days to clear in a bank, and “title-lenders” that lend against the borrower’s car. In both countries these fringes of legal finance are the last defences against a scary, unregulated world of illegal loan-sharking.

Prey for them

In both countries, too, this end of the credit market has caused regulatory concern. Some of the lending is clearly predatory. According to America’s Consumer Financial Protection Bureau, a controversial watchdog set up after the financial crisis, in 2016 more than four-fifths of those who borrowed against their cars had to renew their loans; a large proportion of these end up losing their vehicles. And some payday loans seem designed not to be repaid but to go into default, laying the foundations of a long-term debt relationship. In Britain the regulator, the Financial Conduct Authority, in 2015 imposed interest caps on payday lenders, some of which were charging APRs in excess of 5,000%.

But as Lisa Servon, an American academic, finds in her book “The Unbanking of America”, lenders to the less well-off are not all purely exploitative, nor are they feared and resented by all their users. Rather, they are meeting a need unfulfilled by banks and welfare systems. However, the high cost of their products makes them vulnerable to new entrants to the market. Fired by a mixture of technological zeal, idealism and the profit motive, such firms are competing for the unbanked dollar.

As in the developing world, technology can help in three main ways: by making identity checks easier; by lowering costs; and by enabling new forms of credit assessment. Auxmoney, a German online-credit marketplace, allows loan applications to be submitted entirely digitally and remotely, including an identity check and digital signature by video link. By automating processes and dealing with customers mainly online (usually via a mobile phone), such operators keep down staff numbers and costs. Oakam’s boss, Frederic Nze, says that its cost-income ratio is 50%, and trending downwards to below 40%, compared with 57% for a typical doorstep lender.

Oakam’s rates, which by statute have to be prominently displayed on its website, are high (“1,421% APR representative” in March). But a group of borrowers at their Dalston branch seem unbothered by this. What seems to matter to them is that they are treated decently. One, a rehabilitated drug user and single mother, was so angered by her experience at another lender that she went out and spent her £100 loan on crack. Another says that no bank will touch her because she once splurged on her credit card when she was 18. All are glad to have access to credit at all.

What Oakam shares with other nonprime lenders, and those in poor countries, is a willingness to look beyond the scores handed out by credit bureaus. Those data are backward-looking, ignore much non-credit history, such as regular payments to utilities, and have nothing to say about those with little or no borrowing history (“a thin file”). This often excludes potentially valuable clients: immigrants anxious to build a good reputation in their new homeland; students with bright career prospects; hardworking, trustworthy individuals needing cash to tide them over a difficult patch. These should not be hard to lend to. Ken Rees, the boss of Elevate, says he is constantly meeting people from fintechs advertising their data-processing prowess, yet on examination they mostly just extend the realms of the banked to bring in those who, even on a cursory check, would have been included anyway.

But lenders now have wads of other data, too. Oportun, for example, is an American firm with 270 physical outlets, with its roots in the Latino immigrant community. It offers instalment loans at a typical interest rate of around 32%. One morning in March at its branch in Redwood City, California, three tellers—all Spanish-speaking locals who had first come into contact with Oportun because they or their families had been borrowers—have just one client between them. His documents—some utility bills and a bank statement—are scanned and transmitted to head office. Within minutes, the automated loan approval comes through. Oportun reports its lending to credit bureaus, helping its clients build up their histories. Success, says Raul Vazquez, the chief executive, can be seen as getting them into the formal system. So the business model is to get rid of the best customers, which seems almost perverse.

In rich countries such as Britain and America, where most people have current accounts, their bank statements offer lenders plenty of data that algorithms can feast on. The ability to analyse them better than banks and other rivals may provide a competitive edge. But digital technology also provides data through the apps that users download on their phones. Lenders say they can learn a lot from how, and how often, their customers use their app. Oakam, for example, offers an in-app game in which customers climb a “ladder” of client categories to earn a higher status and discounts. For people at the bottom of the credit pile, it is an apt metaphor.

This article appeared in the Special report section of the print edition under the headline “The bottom rung”

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