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Fintech & Lending

The past decade has given birth to numerous new companies promising to combine technology and finance to revolutionize the lending business.  There has been much enthusiasm for these companies in the investor world – from Silicon Valley to the public stock markets – and for the new industry they’re a part of which has been labeled “Fintech.”  The success that these companies seek is premised upon certain foundational beliefs and observations, some of them valid and others perhaps not so much.

The most important observation is that in the wake of the last financial crisis, the one that saw the world taken right up to the abyss of chaos by the banking system, bank regulators and politicians have tightened the screws on banks, thus leaving much of the demand for loans unmet and opening the door for new lenders.  It seems that this observation remains valid, but is subject to change at anytime given the potency of the banking lobby in DC as well as the ability that cheap debt capital can have to create (at least) the illusion of economic vibrancy, if not the real thing.  In plain English, bank capital flows can swing from tight to loose, and this can have the most profound impact upon the nascent Fintech business and thus must be monitored very closely.

Much enthusiasm for Fintech companies has to do with the notion of them using technology to deliver capital more efficiently, and perhaps without some of the (incorrect) biases that humans do.  There are two distinct elements at play here; one that I believe has permanent merit and thus real value, and one that I’m a bit more skeptical of.  I’m convinced that the lending process, still unbelievably paper-heavy, can and will be massively transformed by technology to be made to be far smoother, and much more efficient and precise.  I also believe that computer algorithm’s born from huge data can steer lenders to better and smarter/safer lending practices, and can help identify qualified borrowers and price risk more efficiently.

What I’m skeptical about is the method of funding loans for Fintech and the non-banking lender model.  Banks have a very mixed record as a lender or evaluator and manager of credit risk, however, the deposit insurance-backed/Fed window-accessing banking model does have the advantage of insuring that they always have money to lend anyway.  Non-bank lenders, including Fintech companies, must constantly earn investor trust, persuading investors to back their lending businesses.  When they fail to do so their lending capacities can shrink to zero rather quickly.  Banks, on the other hand, for better or worse, can have awful lending records but still be flush with loanable funds to meet borrower demand.   This is a real challenge inasmuch as boom/bust cycles are built into the human condition, and during the bust period, when capital is typically in the shortest supply, prices of assets are declining, and fear is dominating greed, investors are loathe to commit more capital thus exacerbating downturns.  For Fintech companies this would be a time of very little access to capital and thus they would be poorly equipped to fund new loans.  For a society that would be dependent largely upon these lenders a cyclical downturn could thus be quite nasty.

For purists, of which I might rightly consider myself one, this would be OK in that the downturn would naturally make assets very cheap and yields very high, thus fomenting the greed that would naturally turn a bust into a boom.  For politicians and their constituents, for whom patience and tolerance for any pain tends to be nil, the hue and cry for intervention to hasten that recovery would be too tempting to avoid.  As such, it would be hard to imagine a move towards a finance system that is dominated by non-banks for the longer haul.  Inevitably, the desire to have the trigger of manipulation that is our banking system is just too damn attractive for societies- both politicians, who love to manipulate as well the general public, who naturally have a low tolerance for pain that emanates from an absence of belief in, or understanding of the free market, and who have little appreciation for the societal costs that the deposit insurance-backed banking system necessarily costs them.

The ebb and flow of Fintech will be fascinating to watch.  I predict that many of the best firms and best technology will ultimately be purchased by banks or will become banks themselves.

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