We see a revolution in the consumer lending process as fintech, with its cutting-edge digital technology and quick decisions come of age. While it looks promising and the growth figures are impressive, to say the least, it still has its downside: the default rates are high.
Why is fintech gaining popularity?
Let’s visualize a situation. We have a consumer in a bit of a financial mess looking to pay off their credit card bills as their interest rates are at a pretty steep rate (rising as high as 21%). To manage the current debt, the consumer is keen on a personal loan that comes with friendlier repayment options. Considering the difficult situation the consumer finds themselves in, they are sure to find fintech with its offerings of online loans more attractive than approaching a bank or credit union. It explains why fintech is expanding its market share phenomenally. A report by The Washington Post and Equifax released back in 2019 reveal that the fintech market share stood at 38% back then itself.
However, there are pitfalls
The Fintech industry offering these non-traditional loans faces a much higher delinquency rate of 3.53% 15 months after the loans are granted. It is almost double the rate the traditional loan market deals with, which stands at 1.77% fifteen months after the loans are granted, as revealed in the study, ‘Fintech Borrowers: Lax Screening or Cream Skimming?’ conducted in 2018 (updated in 2020).
The study doesn’t paint a pretty picture. It was found that those who have taken fintech loans at high interest rates are more likely to be delinquent by almost 40 percent. Their credit scores also show a sharp decline, much more than they do when they opt for traditional loans. It drops by 12 points when fintech loans are taken instead of the 0.9 points when the borrowers take traditional loans.
Di Maggio and Yao (co-authors of the study) feel that fintech companies may be targeting consumers with low credit scores and poor credit histories as they realize that the consumers won’t find traditional loans with comparable terms and conditions. There are, however, no data that substantiate this assumption.
The extent and nature of the problem in India
This phenomenon is not confined to only the US. The leading Indian fintech firms saw their delinquency rates double in a period of one year from August 2019 to 2020, as revealed in a TransUnion CIBIL report. It’ll take time for the delinquency picture to emerge clearly in India. The lagged impact of financial conditions, the changing payment priorities of Indians, and the relief programs the lenders offer are the factors behind this, the report adds.
All the information on unsecured personal loans, the USP of fintech, was supplied by a credit bureau. Di Maggio and Yao studied borrowers based on their age, gender, college graduation, and marital status, a part of a huge sample of 200 million consumers. They also looked into whether the consumers had taken their loans from traditional sources or fintech firms.
Di Maggio has refused to share which credit bureau he partnered with to collect a large amount of data on the default rate of fintech firms. He received the data as those of anonymous consumers. This gave the authors the liberty to match different kinds of loans with the people who took them to locate what type of lender offered which kind of loans.
Therefore, we find that lenders borrowing from non-traditional sources are more likely to spend more than they can afford to, fall into deeper debt, and then default on loan repayment in comparison to those borrowing from traditional sources. It is even though they have matching credit profiles.
As a consumer, you should be careful about how you spend before things slip out of your control. Use the loan for the right reasons only to meet a temporary need. To avoid getting yourself blocked from the credit market, ensure that you don’t spend too much, putting yourself under extreme financial stress. The fintech industry is growing at a very impressive pace but do be cautious of the pitfalls.
You only need to spend wisely to enjoy the benefits of non-traditional loans with easier eligibility norms. As everything continues to evolve, the digital space is always one step ahead. We see new technologies emerge in a blink of an eye while certain pitfalls remain relevant. For instance, the digital space and data are just as unsecured as ever. Of course, millions use a VPN to safeguard both their personal and financial data. However, the latest technologies will evolve, and, hopefully, they will choose the right direction for the best results.