Lenders use old fashioned methods to try to understand modern consumers.
For decades a sophisticated bank would consistently do two things to understand the creditworthiness of a new customer. First, it would check their credit score. Second, it would categorise the customer into a series of broad categories – prime, sub-prime, etc. If the customer met the bank’s predefined criteria an offer would be made. Generic pricing. Generic terms. Generic affordability rules. Generic size. Today the credit score would be more sophisticated, the KYC/AML more rigorous and the technology more advanced. But the fundamental principles remain.
This approach is unsophisticated and fails to understand the human behind the numbers. At the heart of the problem is the credit score. Credit scores look at a consumers’ reported credit history rather than developing a deep understanding of their situation and behaviour. The ebb and flow of an individual’s life is far more complex, and indicative, of their creditworthiness. Lenders are effectively driving by looking in the rear-view mirror instead of at the road ahead.
The result is that today’s approach to credit unfairly discriminates against large groups of people.
In 2022 lenders still only understand potential customers ‘on average’. Millions of creditworthy consumers receive low credit scores, excluding them from affordable lending and forcing them to use inappropriate and high-cost products. For example, in the near-prime segment, which includes c. 15 million UK consumers, about 40% of consumers actually have ‘prime’ credit characteristics and are materially and unfairly overcharged. Factors that drive this inability to access fair finance include a short in-country credit history (known as ‘thin-files’) and those new to credit (e.g., graduates), a disrupted credit history including people who have moved abroad, historic ‘blips’ in credit history which can drag credit scores down for a long time, and a range of behaviours where consumers are simply unaware of the potentially damaging impact on their credit score (e.g., high credit card utilisation or not being registered on the electoral role).
Fair finance, enabled by open financial data, offers the opportunity for positive change.
Innovations in big data and advanced analytics, changes to the regulatory landscape, and the introduction of Open Banking all offer the opportunity for change. For consumers this could mean a true understanding of their financial situation and risk profile, fair pricing, and innovative products that are appropriate to their needs. For lenders the opportunities include increased product acceptance, better automation, greater confidence that credit provided is affordable, operational efficiency, and lower defaults. McKinsey estimates that the impact of systemic adoption of open financial data could add 1-1.15% to the GDP of the UK, EU, and USA.
So far the promise of open financial data has not been translated into action. This matters.
Technology innovations and the introduction of Open Banking mean that the conditions are in place for the adoption of open financial data by lenders. Furthermore, over recent years the start-up ecosystem has been building capacity to allow lenders to start using data sources like open banking (e.g., Tink, Yapily, TrueLayer). However, uptake has been slow. Incumbents have been held back by institutional inertia, technology challenges, entrenched approaches to credit risk, and customer acquisition built around credit score segmentation. Furthermore, incumbents are reluctant to risk breaking acquisition channels by introducing new approaches that could reduce conversion (e.g., customers dropping out of journeys). The result is a set of behaviours that are short-sighted and ignore the commercial opportunities.
Unfair credit may be more important than ever in today’s economy with uncertainty being driven by a softening economic outlook, an emerging cost of living crisis and high consumer indebtedness. At the time of writing (summer 2022) data is mixed on how consumers are responding to the challenges they face. Some appear to be absorbing inflationary pressures with changes to spending. However, tightening of consumer credit markets is likely in most scenarios, and evidence from aggregators show that this is already happening with average credit offers per customer search declining in both June and July 2022 in the UK.
Tightening will be bad for consumers, and particularly bad for those who are mispriced and misunderstood. Traditional lenders are likely to retrench driven by macro concerns, credit score-driven credit analytics, and uncertainty around customers’ true financial situations. Creditworthy consumers will be deserted at their time of need. In this environment, data-driven approaches to creditworthiness will be more important than ever. In a world where affordability can be assessed to a high degree of confidence from a granular and data-driven understanding of individual borrowers’ circumstances, fair finance can, and should, flow.
HP invested in Fintern to build a non-bank champion of fair finance with open financial data at its core.
The Fintern team, lead by Gerald Chappell and Michelle He, are building a non-bank champion of fair finance with open financial data at its core. First, Fintern is building a lender that uses Open Banking and proprietary analytics to x-ray a customer’s finances and build a complete view of their affordability and creditworthiness. This will allow Fintern to provide low-cost finance to a large number of ‘near-prime’ customers who have strong creditworthiness but are not fairly evaluated by the system.
Second, Fintern is productising the Fintern ‘brain’ into a credit decisioning software that will allow others to go beyond the credit score with rich insights from transaction data. Fintern’s SaaS solution allows other lenders to build their own optimised decisioning flows tailored to their business, while leveraging Fintern’s credit AI to deliver both fully automated and guided referral decision flows. By building SaaS for credit decisioning from open financial data, Fintern can scale its impact to thousands of lenders across the world, helping to build a market of fair finance at scale.
We believe the building blocks are in place to deliver this vision. The Fintern team are outstanding and experienced industry practitioners and entrepreneurs. The Fintern technology is proprietary and proven. The data is available at scale. The funding is in place. And the market is broken.
An ambitious plan, but it’s working.
So far, it’s working. Since launching lending in March 2021 Fintern’s consumer lending business has grown at a 30% compound monthly growth rate with an average loan size of £3,600. 80% of customers served have ‘near-prime’ credit scores and are aged 22-40, and default rates are 75% lower than market expected levels given consumers’ credit scores. 50% of customers are consolidating high interest debts into affordable longer-term borrowing, saving on average £2,300 each in interest costs. And Fintern is about to launch its B2B SaaS proposition ‘Render’ for other lenders with an initial set of pilot clients.
The challenge now is to execute the vision at scale and build a champion of fair finance, driven by open financial data.