Let FinTech Help Jumpstart the Economy (originally published in Forbes)
By Nizan Geslevich Packin
Associate Professor, Department of Law
We are in the middle of a global economic crisis. This crisis, which was triggered in large part by the novel coronavirus, is very different from the 2008 financial crisis in fundamental way—big banks, which were at the epicenter of the 2008 crisis, are now perceived as the safe players in the financial markets that will help us weather the storm. FinTech companies, on the other hand, which are nonbank technology companies that offer financial services, are not perceived quite the same way. Just a few months ago FinTechs were giving big banks a run for their money. Now they are in serious jeopardy.
In this time of uncertainty, the pandemic is causing a retreat to the familiar incumbents that survived 2008. Worried investors are moving capital away from anything perceived as risky and the government seeks the advice of and to cooperate with the comforting too big to fail, stable financial institutions. Although decreasing risk is good, FinTech companies are not necessarily “unsafe.”
We should look to the Fintech industry for help in this crisis, not run from it. Fintech companies are typically platforms that operate online, which allows many of them to continue to run seamlessly in the remote-work environment. They are also particularly adept at processing large amounts of data. And they serve populations that the big banks do not, providing financial inclusion that is critical at this time. As such, FinTech can play an important role helping the government administer the recovery from this downturn.
But let’s take a step back. In late March, at a U.S. Department of Treasury Financial Stability Oversight Council meeting, regulators expressed their opinions on the various ways we can deal with the novel coronavirus pandemic’s tragic impact on our economy. FDIC Chair Jelena McWilliams asserted that all FDIC-insured deposits are safe and that banks are prepared to continue supplying capital and liquidity to the American people. But McWilliams also confirmed that the pandemic’s consequences will be especially painful to low-income borrowers, and the 30 million small American businesses, which typically do not have three months of cash reserves. These small businesses employ 60 million people – 47.3% of the private workforce – many of whom have themselves taken unsecured personal loans.
Amazingly enough, in 2019, almost half of those personal unsecured loans were made by FinTech companies. The loans were taken via direct or platform FinTech lending, under borrowers’ pre-pandemic assumptions that they would be able to repay. But even in the pre-pandemic world, studies argued that FinTech borrowers were more likely to be delinquent shortly after borrowing because they are present-biased – they calculate what they can return based on their circumstances today, but underestimate how their circumstances can change in the future. Now, with almost all Americans under a stay at home order, and unemployment rising, many of those borrowers’ financial ability to repay debt has become essentially nonexistent.
During the 2010s, which we already nostalgically think of as the longest bull market, FinTech’s rise was impossible to miss. In 2018 alone, FinTech startups entered into more than 1,700 deals worth nearly $40 billion. FinTech’s loan offerings worked in that bull market because FinTech lenders (such as LendingClub or Prosper) funded their lending business by issuing consumer loan asset backed securities. And they did so to a staggering degree. In 2019, for example, FinTech lenders issued more than $9.5 billion of consumer loan asset backed securities and sold them to the institutional market. However, in this period of economic uncertainty selling to the institutional market is no longer a realistic option. Given the inability to unload the debt, FinTech lenders might find themselves either not extending or rolling credit, or going out of business.
In light of the challenging times, some FinTech lenders are trying to creatively pivot or change their business models. Consider Square, the payment processor whose customers are small businesses, many of which were forced to close. The closure of its customers caused Square’s profits to plummet already several weeks ago. Square quickly realized the predicament it was in, applied and recently received a bank charter. Similarly, LendingClub decided to acquire Radius Bank a few weeks ago. Choosing a different course of action, FinTech neobank, Moven, decided to pivot to selling its IP to financial institutions, as its reliance on outside funding made it vulnerable to market shocks.
There is no doubt that the $2.2 trillion U.S. government stimulus package in the form of The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) will help deal with at least some of the economic consequences resulting from this pandemic crisis. The package includes unemployment benefits, loans to small businesses, $1,200 direct payments to individuals and a $500 billion Federal initiative to corporations. But there are several challenging issues with the administration of the CARES Act with which FinTech companies could prove extremely helpful, if given the opportunity to help.
First, Fintechs can pay a key role in administering the CARES Act stimulus payments to individuals. The stimulus payments are scheduled to be directly deposited by the IRS into the same bank accounts that people used for direct deposit on their last filed return. And, while FinTech companies like Square, Plaid and Gusto have asked to help with this fund processing, so far they have not been included. That’s a shame.
The IRS faces a huge challenge of getting, updating and organizing all the non-duplicated personal information of millions of individuals, including their bank account information and payment amounts. Although eight out of ten American taxpayers have set up direct deposit with the IRS, the others, who have not, could create a huge burden on the IRS. And the IRS could greatly benefit from the help of talented data scientists – the kind FinTech companies have been recruiting over the last decade much more successfully than the government – in addressing this issue. Partnering with FinTech companies that are eager and ready to offer their resources to the government might help shorten the wait for the approximately 28 million Americans that do not have registered bank accounts with the IRS.
Currently the plan is to mail checks to the millions of Americans who have not registered for IRS direct deposit. But many of the individuals awaiting these checks are financially underserved as they are unbanked or underbanked, and precisely for that reason have been the focus of the FinTech industry in recent years. FinTech companies have studied their financial needs, abilities, and even know how to get a hold of them. After all, the FinTech industry has worked hard to become the facilitator of financial inclusion, and FinTech companies have centered their attention on developing technology tools that would help bring more people under the financial services umbrella.
Second, FinTech companiess can play a key role in helping to meet the credit needs of consumers and small businesses. But to do so, the Federal Reserve must help them in the same way it is helping large banks. The Fed has re-established the post-2008 financial crisis Term Asset-Backed Securities Loan Facility (TALF) to purchase asset-backed securities (ABS) from banks. Yet the stimulus plan has intentionally or unintentionally excluded investment-grade ABS loans made by FinTech lenders. Why? Because historically TALF was created for the 2008 consumer financial services market, which pre-dated the rise of FinTech lenders. But because many households have become dependent on FinTech credit over the course of the past decade, excluding them creates a problem. In the absence of access to justly priced loans, particularly now, many people will find themselves needing to get pricier loans or, even worse, getting no loans, at a time that online nonbank lenders could help them.
Finally, the FinTech companies are particularly well-suited to process the enormous volume of Paycheck Protection Program (PPP) applications, which are overwhelming large banks. PPP, which entails about $350 billion in loans for businesses with fewer than 500 employees, got off to a rocky start on Friday, in large part because some U.S. banks are concerned about legal obligations or participating due to capacity constraints in their ability to process applications. Many have tried to limit volume by refusing to service non pre-existing customers.
Fortunately, the PPP program enables eligible “non-depository financing providers” that meet certain conditions to also participate as lenders. This category, importantly enough, includes FinTech companies. Unfortunately, the standards that the participating financial institutions need to meet for participating in PPP include requirements that typical FinTech companies do not necessarily comply with, such as certain anti-money laundering and Know Your Customer laws. As such, FinTech lenders are currently limited to serving as brokers under the PPP, intermediating between customers and traditional banks. But they should not be so limited. Instead, FinTech lenders should be permitted to extend credit to applicants that properly complete SBA Form 2484.
The PPP presents challenges that FinTech companies are particularly well-equipped to deal with; they can handle large volumes of data, automate processing, and increase financial inclusion by servicing underserved communities. FinTech companies, unlike banks, are typically set up to move with speed, and are not hampered by legacy systems. FinTech companies possess the digital, technology, and fraud and risk assessment infrastructure that enables them to verify a borrower’s identity, swiftly approve loan applications, and deploy capital quickly. And later, after establishing a relationship, FinTech companies may also be able to leverage new PPP relationships to offer other related tech-based services to their new cliental.
Time is of the essence for small businesses that could use the FinTech companies’ assistance. A study done by the U.S. Chamber of Commerce last week found that 24% of small businesses already temporarily shut down, and among those that have not yet, 40% will shut temporarily within the next couple of weeks. Time is also of the essence because there is more demand than supply for the PPP funds. Even the interim final rule on PPP implementation, which came out on April 2nd, stated that it applies to applications submitted “until funds made available for this purpose are exhausted.” Accordingly, between April 3rd and April 7th in the afternoon, the SBA has already processed $70 billion in loans for 225,000 small businesses. This amount equals 20% of the funds appropriated for the PPP, so it is not surprising that the Treasury is now seeking an additional $250 billion to fund more small-businesses that need the help.
All of this leads to one conclusion—FinTech companies should be given the opportunity to help us weather this financially rough period. Sure, FinTech companies are not perfect. Their business models have various shortcomings ranging from liquidity issues to algorithmic discrimination, privacy and cybersecurity concerns, and other weaknesses, which have been acknowledged by regulators, scholars and media outlets. But FinTech companies have also increased financial inclusion, in addition to the pace and efficiency of financial services, often at an affordable price tag.
Chairman of the Senate Committee on Small Business and Entrepreneurship, Senator Marco Rubio, stated that FinTech companies should be included as lenders under the PPP. And he is right. Even if some FinTech companies’ loans might fare poorly during this sharp and unexpected economic decline, we should keep in mind that this recession is atypical in that it is not driven by fundamental economic weakness, but by a globally mandated shutdown of economic activity in response to a colossal public health crisis. FinTech companies can help us to implement congressional stimulus. Let’s let them do that!