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Assessing creditworthiness in a time of radical uncertainty

In the first of a two-part series, Josh Cook takes a deep dive into what fintech lenders can and can’t do in a time of crisis.

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To minimise the uncertainty caused by the crisis and keep capital flowing to an economy that needs it the market will inevitably be driven faster towards the automated and data-driven credit assessment models fintech offers. But how can fintech help the market adapt and assess creditworthiness at a time of uncertainty?

The Government’s aggressive interventions in the economy are suspending normal fiscal conventions. The commitments made by a government to underwrite huge loans to struggling businesses and to pick up the tab for furloughed employees has prompted some to wonder if the economy will ever be the same again.

Credit is a central part of the government’s response to the crisis and one rule that will not change is creditors will want to be repaid. How then can the creditworthiness of businesses and people be assessed when the normal rules of the economic system are being suspended? How will fintech play a role in promoting the adoption of new conventions and tools to assess creditworthiness better suited to the crisis?

In the SME sector, fintech leaders are sensing the imperatives of crisis will push businesses towards fintech solutions. Nick Heller, CEO of Fractal Labs told AltFi “this is changing our societal behaviour, what we are going to see is an impetus to digitise a lot of what we do” he says the stakes are too high to be attached to old processes “this is about the survival of the entire ecosystem”. 

The sheer number of SMEs needing support and their importance to the UK economy makes getting capital to them fast a critical challenge. The CBILS scheme has in its early stages seemed too reliant on manual processes and traditional relationship-based ways of assessing business credit risk. 

Three weeks after its launch only £1.1bn of the £330bn promised by the CBILS had been lent out, with only 1 in 5 businesses who have applied for funding having been accepted so far. Despite hard work, the banks accredited on CBILS from the start did not have the processes in place to match the scale of the problem.

CBILS has on boarded more tech focused lenders since launching. Nick Heller, CEO of SME focused open banking platform Fractal – says the pace at which tech-focused lenders were added to the scheme by the British Business Bank “has been slow but understandable” given the scale of the project and the disruption to workflows caused by self-isolation.

The huge challenge of getting the amount of credit needed by SMEs out quickly, while protecting lenders from bad credit, is something only fintech enabled companies have the tools to execute.  

Rob Straathof, Chief Executive Officer at Liberis, another leading SME-focused fintech lender, told AltFi CBILS presents a challenge to incumbent banks who often do not have the “right toolset and the right mentality to assess creditworthiness of small businesses”. Their reliance on manual processes means the traditional banks cannot compete with the speed of fintechs in the space. Straathof told AltFi Liberis, on the other hand, has a “loan application process you can go through in less than five or ten minutes”.

It’s not just operational efficiencies where fintech can provide an edge. As well as opening up the speed of analysis, fintech’s have built their businesses on access to data traditional banks do not have. This provides a depth of knowledge about borrowers that will be all the more essential when the normal patterns of revenue businesses are normally judged against have been disrupted.

Straathof told AltFi “we have the ability of actually getting daily trading data…. whether that’s trading data from Deliveroo or Amazon or financial data through partners likeBroadbase or Lloyds you can make a much better judgement of someone’s risk during the pandemic”.

The technical abilities of these fintech challengers make the market more transparent to them and this feeds into more lending. According to Straathof, even in the best of times, on average incumbent banks have only 50 per cent -30 per cent of the acceptance rate of fintech lenders. This willingness to lend will clearly be key when trying to get £330bn out of the door.

Original thinking around repayment models also makes fintech options more attractive when businesses are dealing with volatility. Liberis, for example, takes their repayments directly from borrowers card transactions, linking repayment directly to business health. No doubt more traditional lenders will be extending payment holidays, but systems that effectively automate the process clearly have the advantage of needing minimal manual input when bank staff time will be at a premium.

Despite these tools, fintech lenders are aware they do not have a silver bullet to keep credit flowing to all those who need it. Heller told AltFi there is no credit-scoring model immune from the crisis; “ecosystems and value chains have been disrupted and that presents a challenge to any form of existing model”. In this environment, he says, “a purely algorithmic approach won’t help”.

The algorithms used by companies like Fractal Labs and Liberis will be based on previous events, something that has clear limitations when going through something which has never happened before. For Heller judgment calls and “old school common sense” will play a role even in the most tech-enabled credit approvals processes.

Similarly, Straathof is clear that even with government backing, at a time when so much business activity has simply stopped risk will be difficult to gauge, “anyone that doesn't have any revenue coming through in this situation is going to be very, very difficult to assess for credit right now.” 

The dimensions of uncertainty added by the crisis cannot be easily unravelled; “You’ll have to make an assumption about how long is how long the crisis will last? How much money is the government going to spend to support these businesses? That's going to be incredibly difficult.”  Fintech can only mitigate the uncertainty in the SME credit caused by the pandemic; it cannot eliminate it.

In the consumer credit space, the crisis will also require more automated data-driven credit-checking solutions. Of course, at this stage, there is no CBILS equivalent for individuals since the government is supporting people through giveaways. If the health crisis morphs into a long term financial crisis the credit market may have to step in to support individuals as government schemes expire. Just as in the SME space transparency created by digitally led insight will ease the risk. 

Freddy Kelly CEO at Credit Kudos- a credit reference agency that uses open banking data- told AltFi he’s expecting the crisis to drive demand from lenders for the richer data insights platforms like his offer, as lenders adjust to the new conditions; “we have kind of hit the reset switch, what was valid at the start of the year is very different to now…when lenders re-enter the market they are going to want as much depth as they can possibly get in order to make sensible decisions”. 

As was written in AltFi earlier this week there is bullishness in the fintech sector that by expanding the kinds of data used in credit scoring models, credit can be opened up to more people safely.

Despite fintech operators working within the same fundamental constraints as traditional banks, it is clear the tools they bring to the crisis will become indispensable in dealing with it. The pandemic may act as a call to arms for actors in the credit market to use the tools available to them in the 2020s to get money to people and businesses so they can ride out the storm. 

Additionally, with the better-capitalised positions lenders are in compared to the last crisis and with the government backing they are receiving, lenders have the chance to step up in a way they were unable to in 2008. Fintech has an opportunity to lead this charge.

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