Fintechs have long provided credit to low-and moderate-income borrowers, but the rising cost of capital and higher cost of living have led to a decline in fintech-originated loans in 2023, according to a research brief published by The Federal Reserve Bank of New York’s Community Development team last week.
The report provided an overview of the growth in fintech originated unsecured lending by analyzing TransUnion data from 2017 through 2023. The report explored how the market for unsecured consumer lending has expanded and how alternative data and underwriting have played a significant part in its growth over the years.
“LMI borrowers have acute needs for short term credit to shore off emergency expenses, make bill payments during financial downturns, and more – while many of these borrowers have had limited choice in credit options from traditional financial institutions, fintech firms have used alternative data/underwriting and other financial innovations to provide unsecured personal loans and other products to LMI borrowers,” Ambika Nair, a community development research analyst at the New York Fed who co-authored the report, said in a LinkedIn post last week while talking about the NY Fed report.
Fintechs built their businesses during the low interest rate environment. Many grew their businesses by entering the unsecured lending space, and by using alternative data to target products to LMI borrowers who have often lacked access to low-cost, short-term small-dollar loans.
As a result, unsecured personal loan balances reached $232 billion by 2023 — up $40 billion from 2022 and $86 billion from 2021, showing a market demand for this type of credit, the report highlighted.
Fintechs originated an average of 1.14 million loans in each quarter in 2023, down from an average of 1.9 million loans per quarter in 2022. The share of loan originations in the second quarter of 2023 was roughly 26.5% of all unsecured loans, but at the same time the percentage of loan originations by banks and credit unions jumped to over 50%.
This change in loan originations from last year to this year and during the pandemic from 2020 to 2021 was due to fintechs’ struggle to manage the rising cost of capital, the report noted.
“Banks and other depository institutions always hold the upper hand when it comes to the cost of funds — they can typically offer the cheapest debt. Funding costs for fintechs are never cheap, but now they are especially expensive,” Patrick Reily, co-founder of Uplinq, told Banking Dive in an email response.
With the change in the economic environment, delinquencies started increasing, prompting fintech companies to grow businesses in cash flow management, financial health and savings offerings. Fintechs have also diversified lending products for LMI borrowers, according to the research.
Numerous fintech firms tightened underwriting and curtailed unsecured personal loans to LMIs.
This led firms to scale back originations and refocus on prime and above-prime borrowers, the report observed.
Fintechs like Uplinq use technology to understand the borrower's economic strength, potential and resilience, Reily said. This helps them to reach protected classes, underserved people and neglected communities, he said.
“The real solution for making sure underserved customers have access to credit is putting fintech that’s compliant with regulatory standards in the hands of depository lenders who can offer the best interest rates – banks. That is the best of both worlds, just like the peanut butter cup commercial,” he said.
