What are the Main Risks of FinTech Credit?
FinTech is booming, as more and more people seek out alternative financing methods to traditional banking and investors. The benefits of these methods are numerous. They give entrepreneurs access to finance that they may not otherwise qualify for. They also give investors the opportunity to put money in new innovative ventures which might otherwise never have entered the market. But, these types of investments also come with their own risks and their fair share of scandals. Those looking for and investing in the alternative FinTech credit market would do well to get to know and understand these risks.
FinTech credit is all credit activities which are facilitated by electrical platforms. This includes – business and personal lending e.g. peer-to-peer (P2P) or crowdfunding, lending against an asset e.g. lending against property and non-debt financing e.g. invoice financing. All these different models have these many advantages and unique risks. Indeed, it was the risks associated with these for of credit financing which has plagued the industry since its conception. Although this article is not exhaustive, these are the main risks to be aware of:
Leverage and liquidity risk – Where banks rely on the wide-ranging scope of their investments to provide enough leverage and liquidity, especially for longer-term and larger investments, FinTech platforms such as P2P platforms can struggle to build up sizeable leverage or provide early liquidity.
Operational risk – Because FinTech is purely online technology-based, it can be vulnerable to a range of security and operational risks. These can be mitigated by working with sophisticated platforms and a robust cyber-security platform, but the nature of working with various third-party providers, such as online data and cloud computing providers, can pose significant risks if due care isn’t taken.
Credit risk assessment quality – Depending on the FinTech provider’s access to big data analytics and the sophistication of their risk assessment models, these types of investments can be at risk, due to lower quality of borrower risk assessment data. At the same time, especially when investing in new borrower segments, there may simply not be enough information available to accurately predict credit risk.
The latter two risks have been the primary drivers for another growing sector: financial regulation technology, otherwise known as RegTech. It aims to minimise the aforementioned risks through greater data analytics, machine learning. Other risks can include business model incentive risk, reliance on investor confidence for new business, platform profitability risk, and the low barriers to entry that the industry provides. And, of course, this relatively new financing method has also experienced several scandals over the last few years, which can deliver a blow to investor confidence.
One such scandal, for example, was the platform failure of Swedish company, TrustBuddy, a P2P lending platform that specialised in payday loans and expanded into consumer loans. After the expansion of their focus, the company reported considerable losses and, when a new management team took over, they discovered evidence of significant misconduct, including using new lender capital to cover bad debts and making loans to borrowers without assigning lenders to the loans. The company eventually filed for bankruptcy, and in the aftermath, prompted increased regulatory scrutiny into the safety of FinTech lending.
It can be argued that no financial investment is without risk, but as this type of lending is increasing, it is critical for everyone involved, including the platforms, investors and borrowers to thoroughly investigate the potential risks and mitigate these as much as possible.