Improving the small-dollar lending experience with fintech

Lenders have more opportunities to participate in responsible and cost-effective small dollar lending.

Recently, the Fed, FDIC, OCC, and NCUA released new guidance encouraging banks and credit unions to explore responsible small-dollar loans (SDL) to consumers. The guidance suggests that new technologies can reduce underwriting costs through additional consumer data and that direct deposit information can help assess and manage credit risk. The additional signals on a consumer may allow banks to improve credit access and stand out in a competitive financial services landscape.

This is a departure from how banks and credit unions traditionally have operated. Historically, small-amount lending has been difficult to implement for consumers with less than perfect credit. SDL can be riskier for institutions: They’re typically not secured, which means there’s no collateral in case the consumer defaults.

In recent years, fintech lenders and challenger banks have stepped up to meet the needs of a population searching for SDL services. With better access to different types of data, fintech lenders have paved the way to reduce risk, as well as expedite the loan process for consumers. Banks can—and have begun to—adopt these technologies into their existing systems. With the new guidance, we anticipate this may accelerate access to small-dollar loans for consumers.

So why are expectations for core lending principles shifting?

The urgency of reaching people in a fast-changing financial landscape
Though the majority of Americans already used tech in some way to manage their finances, the pandemic has accelerated fintech adoption. In a 2020 study conducted by The Harris Poll on behalf of Plaid, 29% of surveyed Americans reported that they used technology even more during COVID-19 to secure or refinance a loan.

Americans’ new financial habits have not gone unnoticed by financial institutions and policymakers. In fact, the FDIC has warned banks that relying on legacy systems will result in lost customers, and that adopting new technology will be key for survival. While the cost to innovate is high and shifting legacy systems requires a heavy lift, banks that can identify and implement solutions to offer SDLs stand to reap numerous benefits. These include short- and long-term profitability, new customer acquisition, and relationship-building within local communities.

Assessing financial health beyond a credit score
As people continue to face financial hardships during COVID-19, credit scores may become increasingly less predictive for lenders assessing a consumer’s ability and willingness to repay.

Even after COVID-19, credit decisioning may look very different. Credit data from the past year and potentially, future years, may be less reliable as an indicator of financial health. Static scoring may also be less predictive amongst impacted consumers and small businesses. Additionally, credit scores may be further impacted by mortgages and student loan payments, which can be deferred for twelve months under the CARES Act.

Lenders should consider exploring alternative methods such as analyzing fluid, real-time data, such as cash flow. Cash flow offers a current indicator of a consumer’s ability to repay, as well as allows a lender to view historical cash flow data for a more complete picture.

More data often means better access to credit for credit-impacted consumers. Lenders should expect to see more competition in the consumer loan space, especially as COVID-19 continues.

Fintech partners can support community banks in this critical moment
Community banks and credit unions that are interested in offering small-amount lending can start with looking beyond traditional credit reports. These may not reflect the latest or most holistic picture of a consumer’s financial health.

Plaid offers Assets, a lending product that provides real-time consumer-permissioned cash flow data. With Assets, lenders can review a point-in-time snapshot of a consumer’s finances, which can be used to assess, size, and price loans that consumers may be approved for.

The consumer-permissioned data typically includes 24 months of transactions, as well as current, available, and historical account balances. The data can be refreshed at any point to pull in the latest transactions and account balances when it’s time to make a credit decision.

More banks and credit unions are taking steps to offer SDL or PAL (Payday Alternative Loans), and many already are. Typically, these are loans to current customers. However, Assets can be used to pull information from outside accounts for these customers or for net new customer acquisition at community banks and credit unions.

Discover solutions for lenders and banks
The new SDL guidelines represent a key moment for fintechs, lenders, and banks to partner on new solutions that leverage financial data to help more Americans. Solutions like Assets can help lenders acquire more customers and stand out as financial leaders from competitors.

To learn more about using Assets for small-dollar lending, send a note to lending@plaid.com or visit our website.