By Devaprakash Ramakrishnan
FinTech small business lending is currently developing with promising potential to complement and emerge as a healthy alternative to brick and mortar banking. The number of small businesses turning to FinTechs or non-traditional lenders has exploded over the past couple of years with many economies reporting a sharp increase in the number of small businesses turning to marketplace lenders in 2017. Marketplace lending accounts for 0.08% of the $96 trillion global corporate and household outstanding debt. Growing at an average 123% a year since 2010, Morgan Stanley forecasts that it will reach $290 billion by 2020.
Unable to overcome the challenges of inadequate trust, confidence and low awareness, the alternative small business lending model is grappling hard to scale with pounding cost of funds and spiralling cost of customer acquisition straddling in a non-comprehensive credit reporting data regime with an uncertain regulatory environment. The challenges faced by small businesses include their severe entanglement in a web of market imperfection on information symmetry and transparency, challenging their ability to decipher comparative costs of servicing loans thus restraining their capability to make informed decisions about loan products. With complex lending contracts leading to varied interpretations, a consistent industry-wide approach is needed to define the best practices in disclosure and transparency.
The worrying factor has been the emergence of ‘fly by night operators’ who, with their unpleasant practices are attracting regulators’ attention to grid-off well run and safe online lenders from the exploitative ones. Financial malpractices are becoming pervasive even with long-time players in a matured market like the US on the malfeasance of financial services providers who then manage to wriggle out of the shadow of massive fraud, miring the industry with long spells of contagion fire lingering un-doused across many geographies. The online finance industry also has to be guarded against over-regulation, a key learning from the aftermath of microfinance crises-laden economies, with recommendations ranging from light-touch regulations, full-fledged supervisions to just disclosures depending on the risk implications of the parties engaged financial services delivery.
Influencing level of fee transparency and disclosures
With the level of fee transparency being highly correlated to the business model, it is important that the benchmarks, definitions and regulations concerning them must apply to a wide range of market players as constituents of fee lead to transparency regarding the Annual Percentage Rates (APRs).
While dishonour of fees should modify from the fixed amount regimen to charging penalties based on the amount in arrears, loan extension fee must become a thing of the past. The penalty for early pay-outs needs to be business model-neutral, offsetting adequately, the degree of capitalising fees into loan principal which is amortised over the course of the loan.
Loan calculator becomes a common tool for SME-clients for comparing loan options so as to better inform on how loans are priced eventually in addition to interest rates. Standardisation and consistency in loan calculator will drive clients towards building greater trust with FinTech lenders. This also applies to some of the high street banks who are found to lace-up the loan calculator with fees.
Against the backdrop of low levels of awareness and a high degree of mistrust amongst the non-bank actors, FinTech lenders are forced to pay a commission to introducers or brokers which goes up to 4% of the loan amount which is normally passed on to clients. It is important that small businesses are made aware of these details of fees, commissions or brokerages paid in the name of client acquisition.
Influencing the behaviour of the banks
One other larger question is also about mainstream banks’ responsibility towards the turnaround time and pricing considerations, especially if they take in an overriding AltFin as a second layer with their portfolio sitting in banks’ books. The time of payment procurement from large companies and MNCs is often the pain point in the supply chain of small business. Thus, self-regulation must encompass invoking responsible behaviour on the whole ecosystem, driven by multifarious actors engaged in small business banking.
Influencing regulatory practices through self-discipline
The UK demands industry-members to publicly demonstrate standardised information and it also makes alternative finance lenders display their APR for balance sheet lenders, forcing P2P lenders as well, to fall in line automatically on the new pricing rule driven by market pressures. The US AltFin’s SMART Box provide standardised product comparison tools, encouraging disclosure and transparency while Canada’s regulators have adopted an improved version of the toolbox. While all these are worthy considerations, there is scope to draw further on wider participation from AltFin industry by agreeing on consequences of non-compliance as well.
Developing a responsible self-regulatory framework will obviate the need for forced guard rails deployed by financial regulators, as evident from UK, US and now in Australia too, with the needle of demand for disclosure and standardisation moving onto Canada. Since the FinTech industry is too regulated it will rob off its entrepreneurial spirit becoming extremely standardised, bereft of any innovative edge. It has to be their endeavour to broaden the scope to embrace differing business models in the non-bank lending industry.