Fintech Credit Markets Across the World: Size, Drivers and Policy Issues

After completing this reading, you should be able to:

• Describe the challenges involved in measuring the size of the global Fintech credit market.
• Describe the factors contributing to the recent growth of the Fintech credit market.
• Examine the potential benefits of and risks involved in the Fintech credit market.
• Compare and evaluate regulatory responses to the Fintech credit market by different jurisdictions.

Challenges Involved in Measuring the Size of the Global Fintech Credit Market

Fintech credit entails all credit activities facilitated by electronic (online) platforms that are not operated by commercial banks, including all credit activity facilitated by platforms that match lenders (investors) with borrowers. These platforms are also referred to as peer-to-peer (P2P) lenders, marketplace lenders, or loan-based crowd funders, depending on the jurisdiction. Additionally, it includes the credit activity of platforms provided by technology companies.

It is complicated to measure the size of Fintech credit because of its small size and diversity. Moreover, since Fintech credit platforms do not lie within the regulatory perimeter in most jurisdictions, thus the official national data are limited. However, data has been collected by academic and industry partners, among others. Utilized with other data, these data construe the size and growth of fintech credits across economies. However, these data present some limitations that make it challenging to obtain an accurate measure of the Fintech credit market.

Limitations in Measuring the Fintech Credit Market

The omission of some platforms: There is a tendency of several sources to consider only the largest Fintech credit platforms, probably because most platforms have minimal turnover.

Exclusion of some types of activity that could be considered as Fintech credit: Online mortgage lenders, for example, are usually left out, even though they automate almost all processes and also match borrowers with institutional investors. In China, the United States, and some Latin American countries, BigTech firms, who have also become lenders, are excluded from most data sources. Therefore, the amount of fintech credit is most likely underestimated for various ‘key’ jurisdictions.

Unavailability of data on the stock of the total Fintech credit: Although various platforms may disclose granular data on loan amounts, interest rates, maturities, among others, the data are not consistently available throughout the whole sector.

Factors that have Driven the Recent Growth of the Fintech Credit Market

The Fintech credit market is proliferating across the world as driven by the quick adoption of cutting-edge technologies in the financial services industry. However, its size still varies significantly in different economies. The following are some of the factors propelling fintech’s credit market growth.

Technological advances: There have been advances in technology in areas of computing power, data sources and data storage, mobile technology, internet, among others. These technological advances promote an innovation spiral in electronic platforms, which include cloud computing services and online marketplaces. Fintech lenders make an intensive use of digital innovations such as artificial intelligence and new data sources. This reduces the transaction costs significantly relative to the traditional credit models. Consequently, they can automate more processes than traditional credit providers leading to increased convenience and quick customer service.

Scalability: Fintech credit platforms can cope and perform well under an increased workload. The scalability can be attributed to the low incremental investment cost as well as ease of standardization of the underlying financial activity. To achieve standardization, Fintech lenders use standardized smart contracts and digital identification.

Cost advantage: Traditional lenders have a relatively high fixed cost base. These costs are incurred on branch networks and the need to maintain the existing IT systems. There are also higher capital and liquidity requirements on loans issued by traditional lenders relative to lending through Fintech credit platforms. Fintech credit platforms can simply structure their activities in the same way as banks and benefit from regulatory arbitrage.

Market gap: In the aftermath of the financial crisis, traditional lenders have withdrawn from some market segments. Moreover, there is a tendency of banks to under service various market segments, for example, micro-business loans, among others. Tax policies and regulations also encourage lending by alternative platforms to these segments.

Higher customer expectation: Customer expectations have grown in the recent past in terms of speed, convenience, user-friendliness of financial services, and cost. The real-time transacting capabilities by the use of internet-connected devices has achieved some of these expectations. The customers have thus opted for Fintech credit platforms instead of traditional platforms.

Demographic factors: Demographic factors affect demand for Fintech in that the younger people would instead go for Fintech credit platforms than the traditional lenders. The so-called ‘millennials’ and ‘digital natives’ are all comfortable with technological platforms. These generations are almost forming the majority of consumers or investors.

The runaways: Consumers with little trust in existing lenders prefer the services of new market entrants such as fintech credit markets.

The degree of competition in credit markets: Less competition in the banking system implies higher margins on bank credit, boosting alternative credit sources such as Fintech credit markets. Furthermore, the traditional lenders have had no greater reach to potential customers leaving a gap that Fintech can explore. Fintech credit could take advantage of jurisdictions with difficulties in accessing credit.

Potential Benefits of Fintech Credit Market

Lower costs to borrowers: Fintech credit platforms offer lower interest rates to borrowers and higher returns to investors. This has been made possible by the intensive use of digital technologies, reducing operational costs by dissolving physical branch networks and automating loan application and pricing processes as well as credit risk assessment. Moreover, Fintech lenders outside prudential regulation are enjoying lower associated regulatory costs.

Faster and more convenient access to credit: Fintech credit markets are online platforms, which allows them to provide more convenient services to customers. The online loan application process and risk assessment help speed up processes for borrowers and investors. Borrowers get an initial indication of whether they pass the lending criteria or qualify for a loan offer. Retail investors have benefited from the ease of the lending process when making decisions about lending through peer-to-peer (P2P) platforms.

Expanded access to credit: Fintech platforms have widened access to credit. P2P lending, for example, has substituted bank lending for inframarginal bank borrowers. It also complements bank lending for small-scale loans. Moreover, invoice trading platforms reduce the need to draw on potentially more costly bank overdrafts.

Potential Risks Involved in the Fintech Credit Market

Like any other industry, the Fintech credit market faces several risks. Some of the risks that the Fintech credit market faces include but not limited to, the following:

Procyclicality risk: Due to the increased access to cheap debt and equity financing, some entrants could underprice risk while competing with incumbent lenders. If the entrants and their investors can bear that risk for an extended period, then the incumbents may be forced to compete at lower prices/compensation, increasing the risk involved.

Leverage and liquidity risk: Most Fintech credit platforms act as agents, matching borrowers with investors, and thus are not leveraged like banks. Their lending model does not include liquidity risks as loans and investments are simply duration-matched. This means that investors are unable to liquidate investments before loan expiration unless they can find other investors willing to take over the investment.

Operational risks: Fintech credit platforms are more vulnerable to various operational risks than banks. The degree of the risks depends on the degree of sophistication of the platforms, the mechanisms they use to store client information, and the robustness of their cyber-security programs. Due to their heavy usage of information technology, Fintech lending is reliant on third-party providers, including online data and cloud computing providers. This renders them prone to the impact of any disruptions of these outsourced services.

Quality of credit risk assessments: Fintech credit platforms should accurately price credit risk to deliver acceptable risk-adjusted returns. They depend on the use of big data analytics to improve borrower screening and loan pricing. Consistent with this, some banks have begun to use proprietary FinTech credit risk models for their lending. However, the models have not yet been tested through a full credit cycle. Furthermore, the quality of data used to model borrower’s risk by the platforms may not be as comprehensive relative to traditional lending. Information, such as wealth, income, and total outstanding debts, may not be available in some platforms’ due diligence documents.

Business model incentives: Fintech credit platforms, especially those who do not lend on-balance sheet, might have misaligned incentives in their agency lending model, thus adversely affecting the quality of credit risk assessment. Specifically, lenders may be motivated to approve new loans for fee revenue generation but not directly bearing credit risks on those loans.

Low barriers to entry: Fintech credit markets appear to be less regulated in many countries relative to other financial services due to their online product distribution and the wide availability of the data sources. In other words, there are low entry barriers of fintech credit markets into the industry. This can explain the massive flow of entrants into the fintech credit markets over recent years. However, a large number of banks have substantial resources and could decide to invest in big data analytics and risk-based capital. This would increase pressure on fintech credit platforms.

How Different Jurisdictions have Crafted Policy and Regulatory Responses to the Fintech Credit Market

Following the financial crisis of 2008-2009, authorities in different jurisdictions have imposed regulations on financial service providers to ensure that a similar crisis is not replicated in the future. In many jurisdictions, Fintech firms have fallen out of the regulatory perimeter due to their small size, among other reasons. However, Fintech firms are involved in some bank-like activities such as lending. The following is a discussion of how different jurisdictions have imposed regulations to these market entrants.

United States

In the US, all platforms engaging in credit origination are subject to licensing requirements in the state they operate. This policy has resulted in many platforms partnering with banks to originate loans agreed online.

Germany

In Germany, credit platforms are prohibited from their involvement in lending without a banking license and related prudential oversight.

Brazil and Mexico

In 2018, Brazil and Mexico introduced new rules and licensing practices subjecting licenses to operate Fintech credit platforms as general requirements for adequate governance and risk management arrangements.

China

In 2016, the Chinese authorities introduced new rules that prohibit various high-risk business models and practices. They also mandated filing and information disclosure requirements and introduced requirements for Fintech credit intermediaries to guard against lending concentration.

United Kingdom

In the UK, platforms are subjected to standard requirements to ensure appropriate systems and controls to manage risks. They also require them to focus on robust governance arrangements, knowledge, skills, and expertise of staff, record-keeping, and conflicts of interest, among others. Moreover, they have capital requirements in place that increase with a platform’s lending volumes, but no liquidity requirements.

France

France authorities have imposed regulations protecting investors. Fintech lenders are required to provide information to investors about the borrower’s investment project, its potential return as well as the associated risk.

Spain

In Spain, authorities require the platforms to verify information provided by the promoter to prevent fraud. Besides, they require lending platforms that handle money movements and payments to get authorization to act as payment institutions. This means that such platforms must comply with the regulations applying to such institutions, for example, safeguarding clients’ funds, anti-fraud, and money laundering. Furthermore, the authorities have put in place capital requirements that increase with a platform’s lending volumes.

Practice Question

A. Higher customer expectation

B. Investors ability to liquidate investment at will

C. Access to better quality data compared to banks

D. All of the above

The correct answer is: A).

Customer expectations have grown in the recent past in terms of speed, convenience, user-friendliness, and cost of financial services. The real-time transacting capabilities by the use of internet-connected devices has achieved some of these expectations. Customers have thus opted for Fintech credit platforms instead of traditional platforms.

B is incorrect: Investors are not able to liquidate investment at their will as they need to find other investors willing to take on their investment.

C is incorrect: Fintech credit platforms data is not quality relative to the one that banks can access. Banks are able to understand customers’ wealth, as well as spending habits, something the platforms can’t access.

D is incorrect.