One day, in 1949, a Chicago businessman named Frank McNamara invited some guests to dinner at Major’s Cabin Grill, a famous restaurant in New York. When it came to paying the bill, however, he suddenly realized that he had left his wallet in the pocket of another jacket at home. Embarrassed, McNamara had to call for his wife and ask her to bring cash to the restaurant and settle the bill for him. This incident did, though, fill him with inspiration that would eventually change the way that society as whole thinks about personal finance.
McNamara became fixated with the idea of finding a way for people to eat at restaurants and pay on credit. Eventually, he decided to organize the Diner's Club with a group of colleagues, including Ralph Schneider, Matty Simmons and Alfred Bloomingdale. Together, they devised a system whereby a form of ID made of cardboard could be used as a membership card in restaurants. The world’s first credit card was born.
At first, credit cards were only used by the wealthy, who used them while traveling or while pursuing leisure activities. Diner's Club soon established a nationwide network in the United States, and charged a rate of 7 percent commission on transactions. It was not until 1961 that plastic cards made their debut in the world of personal finance. But perhaps even back then, nobody would have been able to guess that these small pieces of plastic would so quickly revolutionize the way that the world does business.
Several decades later, the latest buzzword in the world of personal finance is “Fintech,” a compound word formed from the words “finance” and “technology.” An increasing number of people have begun to claim that maintain that Fintech trends are having a disruptive influence on existing financial systems. However, others state that Fintech is actually having a positive effect – they say that it is opening up niche markets and breathing a wind of change though the world of finance.
As ATM machines have become more common in residential and commercial areas all over the world, the amount of high street banks is beginning to decline. Internet banking and other high-tech solutions are also contributing to the diminished role of bank branches in modern society.
Due to the regulations put in place by the Basel Accords (the first of which was put into place in 1998), large domestic banks have increasingly begun to focused on financing conglomerates with high credit ratings and providing individuals with mortgage loans, as well as providing loans for public sector workers.
This has made it increasingly difficult for small- and medium-sized enterprises, small business owners and people with poor credit records to gain access to bank loans. Even if an individual borrows money when their credit rating is high, their credit rating could be lowered suddenly, meaning that this individual’s subsequent requests to extend the term of any loans could be turned down should the lender forget to pay interest for a couple of days. It is no surprise to hear people nowadays complaining that banks are taking their umbrellas away when it rains and lending them back when the sun shines.
Peer-to-Peer Lending (P2PL) is currently on the rise in Britain and America, and is also starting to become popular in China. Zopa, the first service to launch P2PL in the United Kingdom, grants individual loans. Another company, Funding Circle is targeting corporations with its business model. Magazine The Economist has reported that companies Prosper and Lending Club currently account for 98 percent of the P2PL market in the United States. Lending Club finished its first trading session at US$23.43 per share, 56 percent up from its offering price when it was listed on the New York Stock Exchange on December 11, 2014.
Zopa is an abbreviation that stands for “Zone of Possible Agreement.” The company sees lending as a form of negotiation. Under the terms of the Zopa service, lenders offer rates of interest and periods of repayment that suit them best; and borrowers, in turn, choose the best options for them. However, loans are limited to small sums in order to minimize the risk for lenders. For example, in case that a borrower is looking for a GBP500 loan, amounts of ten GB pounds (or even less) can be provided from more than 50 lenders.
Prosper, meanwhile, uses a system of reverse auctioning, whereby a lender can offer low interest loan rates after performing checks on the financial situation of the borrower. In the United States, JOBS (Jumpstart Our Business Startups) has provided a legal framework for enterprise-type P2PL systems since 2012. This legislation protects private investors by limiting their annual investments to within US$2,000 or 5 percent of their annual income for individuals with an annual salary of US$100,000.
Another service, OnDeck, makes use of merchant cash advances, whereby lenders can loan large sums of money to business ventures while card sales made by the business venture are transferred to lenders’ bank accounts. The remaining funds are then wired to the venture after payments have been deducted. This system ensures that borrowers do not remain as just individuals, but transform into business investors whose companies can display good economic health, with their card sales rates serving as a form of collateral.
OnDeck is a bank with no branches. It was founded in 1993 by a then-student named Mitch Jacobs at Dartmouth College, in New Hampshire. Jacobs was awarded an Entrepreneur of the Year prize in 2010 by Ernst & Young. OnDeck uses a sophisticated system to screening the eligibility of its loan applicants. It makes use of software to analyze thousands of variables that include cash flow, credit ratings, assorted social media data and public records to create an OnDeck Score. It can take anywhere from a few minutes to a couple of hours to calculate an applicant’s loan eligibility.
OnDeck was ranked 11th on a list of America’s most prospective enterprises in 2014. As of 2013, OnDeck had lent a total of US$1.5 billion, and it is estimated public worth was set at US$200 million after it was listed on the Stock Exchange on December 17, 2014.
Such technological breakthroughs ensure that loan screening can now be done at high speed, something that traditional high street banks are still not able to offer. This means that technological solutions can now amass sufficient information on their customers to perform a full analysis of their financial conditions.
FICO scores, a credit rating evaluation system operated by software company FICO, now play an integral role in lending. FICO scores are assessed by assessing five factors, including payment records (comprising 35 percent), sum of loans (30 percent) and periods of credit transaction (15 percent).
A Korean credit bureau named KCB makes its credit evaluations based on: debt levels (comprising 35 percent), overdue payments (25 percent), credit types (24 percent) and periods of credit transaction (16 percent). In the United States, credit-rating agencies often hesitate over due diligence involving companies that apply for loans of less than US$100,000 because of the cost and time involved. This is the niche market that the likes of OnDeck have moved into.
According to FICO’s standards, a company or individual is classified as having bad credit scores if they have no records of borrowing or using credit cards, a factor that can lead to the said person or company having a reduced chance of securing a loan – as well as having to pay a higher rate of interest on loans. Nonetheless, applicants’ status can now also be judged by their online activities on social networking platforms such as Facebook and Twitter. If the applicant is deemed to have a large social network, and appears to be a powerful figure with a good reputation, they can qualify for good credit ratings.
This new approach takes a very different tack from that which is used by more traditional financial institutions, and makes use of very different criteria as a means of assessing credit ratings. A person’s social standing, online reputation and online presence are now being used to factor credit evaluation, revealing a brand new use for the ever-growing world of Internet-based social networks.
However, it would be wrong to look at the developing world of Fintech business through rose-tinted spectacles. It is only natural that a level of risks is involved with all forms of loans. Even as the recipient of an optimal AA credit ratings score, Prosper is, nonetheless, expected to experience 2 percent yearly losses. In China, a large amount of P2PL service-providing venture startups have already failed.
In Korea, meanwhile, P2PL services almost all operate in the field of investments so far, but many restrictions on such services currently exist, as services like this are currently taxed at a rate of 27.5 percent, which is the rate of interest of non-business-related loans, rather than at 15.4 percent, the current rate of interest income tax.
