This week, I’d like to focus on a fintech trend that’s been taking place over the past few years: fintechs using cash flow underwriting to make it easier for people to have access to credit and build their credit history.
Enter TomoCredit, Kafene and Petal – these companies skirt the FICO system by creating new ways of determining a person’s credit worthiness by using their bank account data.
They essentially link a person’s bank account with a credit card, and establish regular payments – some do weekly payments, as a higher payment frequency helps with building a better credit score.
If a customer misses a payment, the credit card is frozen. In the case of Kafene, if borrowers can’t make their payments, they can cancel the agreement, and the fintech takes the loss without impacting their credit scores.
The three companies have all reported growing numbers of customers, appealing especially to younger generations that are just starting their credit journeys. Petal is actually nearing unicorn status - raising $140 million a few weeks ago to bring its valuation to $800 million.
Their business case is that credit bureaus don’t have the best data on people who have never been issued credit. In the US, there are many people with a bank account who never had credit cards and have trouble getting one. They represent the unbanked and underbanked consumer, an individual who lacks a credit history and usually gets denied by traditional lenders.
The idea of looking beyond credit scores and using alternative ways to determine credit worthiness is not new. But what is new are these options: say, an immigrant coming to the US has to begin building credit.
When I was in that position a few years ago, despite having a stable job at a FTSE 500 company, a social security number and a bank account, it still took me 1.5 years to get approved for my first credit card ever.
Coming from Europe, where credit cards aren’t as popular, I didn’t even understand why I needed to “pretend” to be in debt, only to pay the debt off every month, for the sole purpose of building my credit score. I was a revolted European bemoaning the ridiculousness of the whole system.
But I soon found out how essential it was - I couldn’t even get a SIM card plan without one, let alone rent an apartment. America converted me, and I was soon making regular pilgrimages to my local branch to enquire if I was eligible for a credit card yet.
TomoCredit’s CEO, Kristy Kim, had a similar experience as a young immigrant coming to the US for school, and this motivated her to build a solution. She told me that big banks agreed with her that it was a big pain point for younger consumers who don't have a credit score – customers that they were missing out on.
They weren’t so eager to fix this, though. Kim initially wanted to build such an underwriting solution and license it out to the banks, but that would have taken 5 to 10 years, so she did it herself. In just one year since launching, TomoCredit received two million applications with zero marketing budget.
Across the pond, companies like Credit Kudos are using open banking in the UK to look at transaction data to build a product that more accurately predicts risks than traditional credit bureaus. The company wants to give people better rates by using bigger data and smarter algorithms.
Credit Kudos also embeds the process in the loan application journey. The customer is given the option to use open banking to complete the loan application through a consent window -- just a button like when buying something with, say, PayPal.
There is a big demographic of people that want to enter the credit system. And more ways to determine credit worthiness can also be positive for lenders as it would widen the pool of borrowers.
It’s all about data at the end of the day – who has an accurate picture of a borrower’s financial capabilities, a strongly predictive algorithm. The action is happening there, behind the scenes, bit by bit. These fintechs think of themselves as data companies first, looking to accumulate better insights to roll out other lending products in the future.
And if that means a more equitable financial system for everyone, hey – I’m all for it.
Chart of the week
It’s getting a little bit crowded at the point of sale… Begs the question if all these options are creating a healthy system of spending for an individual. I, for one, am feeling a little overwhelmed. At least they all chose different colors.
Studies are showing that if a consumer had multiple BNPL accounts open at once, they were more prone to overspending, missed or late payments, and poor credit history. According to the survey, 57% of BNPL users said the service has caused them to spend above their means (i.e. buying things they normally couldn't afford upfront).
No wonder BNPL companies have been attracting more attention from regulators. The CFPB said it was specifically worried about how quickly consumers can accumulate debt using BNPL services, as well as how their data is being handled.
Quote of the week
As banks try to up their digital game, they might be getting too optimistic in their view of how far ahead they’re getting, according to Ron Shevlin, Chief Research Officer at Cornerstone Advisors.
“Banks’ perceptions of how far they’ve come in their digital transformation journeys don’t jive with the impact they think they’ve seen. Bank and credit union executives are holding a loaded gun pointed at their feet. The name on the gun is “digital transformation.” Banks are deluded into believing they’re digitally transforming their organizations when all they’re doing is deploying new tools for yesterday’s industry.”
To their defense, respondents to Cornerstone’s survey argued that banks are tied to their digital vendors – who are proving to be kinda slow:
“While fintechs and other vendors tout that even small institutions can compete digitally, we are handcuffed by the slowness and unwillingness of core providers to support integrations. And have found that what is in the sales pitch then has challenges to overcome in order to accomplish, even if possible.”
What we’re reading
- Banks are starting to give credit cards to borrowers with less than pristine credit
- Consolidation of the BNPL industry: what does it mean?
- Mastercard strikes NFT payments deal with Coinbase amid a wave of recent crypto partnerships
- Fintech startup Milo is offering 30-year 'crypto-mortgages'
- Amazon halts plan to stop accepting Visa credit cards in the UK.
What we’re writing