The New Wave of FinTech Lending — 7 Essential Strategies

FinTech lending today leverages data, technology, machine learning, and digital marketing to better target, underwrite, and serve customers. These capabilities are now table-stakes.

A new wave is coming: FinTech Lending 2.0. These FinTechs focus on finding innovative ways to de-risk borrowers to offer cheaper and more customized products. 7 strategies stand out that will define the next generation of FinTech lenders and leave the rest struggling to stay relevant.

FinTech Lending Strengths: 1.0 vs. 2.0

FinTech Lending 1.0 — what was once disruptive is now table-stakes.

Just yesterday, “alternative data” and “digital lending” were all the hype. An onslaught of online lending companies started lending billions to consumers and SMEs. Today, FinTechs make up 38% of the lending market, up from 5% only 5 years ago. How did this happen?

A wave of technology enabled startups emerged to provide more accessible, affordable, fast access to credit. To do so, FinTech Lending 1.0 players leveraged the following competitive advantages:

1. Vast amounts of data. The proliferation and digitalization of data has given FinTechs large datasets on which to build models. This data ranged from formal credit bureau and KYC data, to more alternative data such as biometrics, phone data, social media, bank transactions, etc. Access to such rich data has enabled FinTechs to better assess who the borrower is and how risky the borrower is.
2. Technology infrastructure. B2B technology platforms have made it even easier to quickly spin up a company with limited funding and ongoing operational costs. Everything can be outsourced to vendors today, from call centers, website design, payments, underwriting, loan management systems, CRM, database and hosting, security, etc. All FinTechs have to do is focus on their value proposition to the customer.
3. Machine learning models & computational power. Data science practices and tools have made it even easier to build robust underwriting models. Accessible computing power via the cloud also made it possible to develop these models on large amounts of data. Combined, these capabilities enabled FinTechs to more accurately predict credit risk via an improved internal credit score.
4. Digital marketing & distribution. The rise of digital marketing has allowed FinTechs to skip past bank branches for distribution. FinTechs can advertise, inform, process applications, underwrite and distribute loans via near instance payment technology — all online at a fraction of the cost.

It was the perfect storm. More data + better technology + better models + better distribution => lower cost of acquisition + lower credit risk + lower operational cost => growth and profitability.

Banks that did not invest in any of these capabilities had a tough wake up call. Many partnered or acquired FinTechs to stay relevant. Most stayed alive due to their deep pockets, sticky products, and lower cost of capital through their banking licenses. Today, these 4 characteristics are table-stakes for any FinTech player. What about tomorrow?

FinTech Lending 2.0 — the next wave of disruption.

With more data becoming publicly available, cheaper FinTech infrastructure, open source AI capabilities and commoditized marketing strategies, FinTech lenders need to start looking elsewhere to remain relevant. No — your data science team is not a competitive advantage.

FinTech lending 2.0 focuses on more than just data, technology, digital marketing, and machine learning models. They focus on finding innovative ways to de-risk the borrower so as to drive down default rates, which converts to more competitive pricing and broader reach.

Here are 7 strategies used by leading FinTechs based on research from around the world that will define FinTech Lending 2.0:

1. De-risking through financing
2. Ensuring repayment behavior
3. Focusing on positive selection
4. Aligning incentives
5. Upping the stakes
6. Leveraging another line of business
7. Focusing on niche markets

1. De-risking through financing

Strategy: Ensure value by controlling what the loan is used for.

• FinTech 1.0: “Here’s some money”
• FinTech 2.0: “Here’s some value”

Unsecured lending to consumers is often abused which not only hurts customers but often leads to default. Instead of lending directly to consumers or businesses, some FinTech companies are providing the funds for specific activity that improves their financial health. Examples: Input Financing (Apollo Agriculture), Invoice Financing (Investly), POS financing (Affirm). Apollo lends inputs to farmers to ensure that the capital is directly used to help their business thrive.

2. Ensuring repayment behavior

Strategy: Guarantee repayment through automatic deductions.

• FinTech 1.0: “This is a kind reminder to pay us back”
• FinTech 2.0: “Thanks for your payment”

One of the best ways to de-risk getting paid back is to remove the need for the customer to do anything, and ensure they will have the cash flow. Doing so requires having access to the borrower’s future cash flows and deducting payments automatically from them. Examples: payment companies that lend and take a percentage of future payments (Square, Stripe), salary loan companies that deduct payments automatically from a future paycheck (Uploan).

3. Focusing on positive selection

Strategy: Access the right borrowers through B2B partnerships.

• FinTech 1.0: “You have been targeted”
• FinTech 2.0: “You have been selected”

Selecting the cream of the crop to lend is a great strategy to de-risk customers. FinTech 1.0 leveraged marketing for this. SOFI, for example, provided student loan refinancing marketed to “HENRYs”. This became its cornerstone business. FinTech 2.0 leverages partnerships. Many lenders are partnering with employers or exclusive communities and providing their services as benefits. This strategy has many benefits including reducing risk (lender knows you are employed), decreasing cost of acquisition and creating competitive barriers to entry. Examples: Salary Loans (Uploan), exclusive clubs (Cred), employee bank accounts (NOW money).

4. Aligning incentives

Strategy: Invest in your customers.

• FinTech 1.0: “Pay us back in 30 days”
• FinTech 2.0: “Pay us back if you are successful”

Providing capital to consumers and small businesses does not have to be in the form of a loan. Another option is to invest in borrowers. Doing so decreases the cost of borrowing, aligns incentives, and helps FinTechs reap the rewards. FinTech Lending 2.0 blurs the line between equity and debt. One example is home ownership financing: instead of providing a mortgage, some lenders are also buying a stake in the house (ZeroDown, Unison). Another example is student loan financing: instead of providing a student loan, some lenders are providing Income Sharing Agreements and get paid back if the students get a high paying job (Lambda School, Blair).

5. Upping the stakes

Strategy: Add incentives through micro-securitization.

• FinTech 1.0: “Pay us back or your credit score might be affected”
• FinTech 2.0: “Pay us back or you will lose your electricity”

One way to de-risk consumers is to secure the loan with what it is used to purchase. Wave 1.0 focused on large securitization such as car loans or mortgages — but technology enables you to securitize much smaller assets. Examples: solar panel financing (MKOPA), phone financing (PayJoy). If consumers stop paying their loan, the phone gets locked or the solar panel stops working. More incentives = less defaults = lower rates.

6. Leveraging another line of business

Strategy: offer loans to existing customers.

• FinTech 1.0: “We’re a lender”
• FinTech 2.0: “We’re a tech company, but we also offer loans”

In the near future, every company will become a FinTech company. There is a rise is FinTech investment from many of the large tech companies: Facebook with FacebookPay, Google opening up checking accounts, Uber with Uber Money. These companies know you better than your primary bank and have a lot to benefit from owning your wallet (e.g. more data, lower payment costs, higher margins, etc.). Better yet: 0 cost of acquisition. Examples: payroll companies (Gusto), e-commerce (Amazon), large tech (Facebook, Google), etc.

7. Focusing on niche markets

Strategy: deeply understand and cater to specific segments.

• FinTech 1.0: “Our customers are people with FICO scores between x and y”
• FinTech 2.0: “Our customers are millennial head of household gig economy workers”

FinTech Lending 2.0 sees beyond the FICO score. Players understand that no two lenders are the same. They focusing on specific segments and build everything around them: marketing, copy, design, accessibility, features, pricing, resources, support, etc. Doing so helps them better attract and retain customers. It also builds strong equity through community which keeps them to of wallet. Examples: W2 workers (Catch), retirees (TrueLink), students with debt (Summer), immigrants with credit history (Nova Credit), etc.

These are just a few strategies that will become essential as FinTech Lending continues to expand.

What innovative digital lending strategies have you discovered?