Fintech in a changing world
Good morning! I’d like to start by welcoming everyone here to Philadelphia and those of you joining us virtually. One of the benefits of hosting a hybrid conference like this is that we get the benefits of being together physically – I’ve had some of my best ideas from the sidelines of conferences like this – while being able to accommodate many people who couldn’t make it to Philadelphia.
It’s great that we have such an attendance today. I think it’s a testament to not only the growing interest in the topic we’re here to discuss – fintech – but also the stellar lineup we’ve assembled for it, the Philadelphia Fed’s Sixth Annual Fintech Conference. My colleague Julapa Jagtiani, the organizer of these debates, has really done it again. If you’ve never attended one of our fintech conferences before, trust me, you’re in for a treat. Over the next two days, we will hear from key voices from industry, government and the Fed.
And speaking of the Fed, here’s where I give my standard Fed disclaimer: The opinions I express today are my own and do not necessarily reflect those of anyone on the Federal Committee on open market (FOMC) or the Federal Reserve.
Our last fintech conference was in November 2021, and while it’s not even a year ago, I think it’s safe to say that the conditions in the fintech industry – not to mention the economy in general – have changed dramatically.
I will give an example. Last November, I spoke about the rapid growth of buy now, pay later companies, which effectively repurposed Kmart’s old layaway model for the digital age. With buy now, pay later, shoppers can split payments for purchases into a series of installments, sometimes interest-free. And unlike layaway, consumers benefit from buying the product up front and paying for it over time. This has proven to be a popular option, with buy now, pay later accounting for $2 of every $100 spent on e-commerce in 2021.
Buy now, pay later looked robust in a low interest rate environment. This is because the vast majority of companies in the space have no depots to operate. Instead, they borrow money which they then return and lend. Typically, their revenue comes from fees charged to merchants.
Rising rates have dramatically changed the landscape to buy now, pay later. Forced to borrow at higher rates, these companies are facing pressures they simply did not experience last November. Unsurprisingly, major operators in the space have cut staff, with one major lender losing 10% of its workforce last month.
The fintech landscape is rapidly changing due to macroeconomic conditions. Important developments are happening, and we’re lucky to have so many superb panelists here this week to discuss them.
The adoption of buy now, pay later has important implications for the provision of financial services to low- and middle-income consumers or others who may be excluded from more traditional means of obtaining credit. Consider a young adult in her first job who does not have an established credit history and therefore cannot get a bank credit card approved. She can now use buy now, pay later to fund that big purchase. Additionally, some lenders buy now, pay later report payment history to credit bureaus, allowing these new borrowers to begin building a credit history.
Or think of the family who declared bankruptcy several years ago and who continue to be charged high rates on traditional forms of loans, even though they have regained their finances. Buy now, pay later offers another method of accessing credit.
A Philadelphia Fed survey of buy now, pay later users in the US found that users are generally non-white, earn less, and are younger than users of other payment methods like cards debit and credit.
In other words, fintech can help foster financial inclusion. It’s undeniable. But it’s far inevitable.
Like all tools, fintech can be used for better, for worse, or somewhere in between. Just as fintech can foster legitimate frictionless transactions, for example, it can foster fraudulent transactions as well. Fraud is an example where a little friction can be a good thing.
Fintech has grown a lot in the six years we’ve hosted these conferences, and discussions like the ones we’ll be having over the next couple of days have moved from the largely theoretical realm to the empirical. We have increasingly rich datasets here in the United States and abroad that provide important insights into how fintech is reshaping credit markets.
Consider an example: a recent article looked at how fintech lending differed from traditional bank lending in China at the start of the COVID-19 crisis. By analyzing the dispersion of unsecured personal loans by three large fintech companies and a large commercial bank, the researchers found that fintechs were more likely than banks to extend credit to new borrowers with financial constraints. Fintech borrowers were more likely to be unemployed, earn lower incomes, and have past defaults.
A happy story, right? Well, not quite.
Indeed, it turns out that the delinquency rate of fintech loans tripled after the COVID-19 epidemic, while there was no significant change in the delinquency rate of bank loans during of the same period. This is a puzzling finding, somewhat suggesting that, in this case at least, fintech lenders were unable to accurately predict the financial health of borrowers in the event of a pandemic, but commercial banks l ‘were. This strongly implies that Chinese fintech companies were operating with imperfect or insufficient information about their borrowers. Although extending credit to financially constrained people is potentially beneficial, it does not benefit lenders or borrowers if loans end up in default.
But it’s not an iron law: other examples have shown that fintech loans are delinquent at lower rates than bank loans. This suggests that higher or lower credit risk is not necessarily inherent to fintech itself, but rather depends on each company’s particular business model.
Another recent article examining unsecured small business loans in India offers an important example. There, the authors found that when fintechs used a more holistic method to assess borrowers’ credit risk than just a credit score, both borrowers and lenders benefited.
For several years, Indian small businesses seeking credit from fintechs have agreed to share data on their so-called cashless payments, certified checks, internet banking, mobile banking, point-of-sale transactions and transfers. money on mobile apps. The result ? They had access to larger loans at lower rates than those who used traditional credit scores to access credit.
One can imagine such a model working here in the United States, where constrained credit is able to demonstrate its creditworthiness in ways other than its credit ratings. In my opinion, there’s no good reason why paying rent and utilities on time shouldn’t be as critical to getting credit as paying car loans or credit cards on time.
Again, the opportunities to use fintech to reach economically constrained and financially marginalized people are truly exciting – and very significant. Now it’s up to all of us to seize them.
So again, thank you very much for joining us. We have a very rich menu of programming over the next two days, which I’m sure we will all enjoy.
I will now hand over to David Mills, my colleague from the Board of Governors, who will lead a discussion on the future of payments.