Distribution of emergency SBA loans is a major step that recognizes the importance of financial technology companies, and may be a harbinger of broader regulatory acceptance of digital banking in the U.S.
Friday, May 1, 2020
By Peter Went
Fearing the risk of community transmission during the SARS pandemic, users in Asia flocked to a small online e-commerce company, Alibaba, helping it reshape e-commerce and finance. Persistent social distancing, quarantines and limited mobility required then - as it requires now - new solutions.
Unlike previous economic crises, this time finance is not perceived to be part of the problem; rather, financial technology companies (fintechs), in particular, are rapidly becoming part of the solution to the coronavirus pandemic. As many traditional bank branches shuttered across the globe amid the pandemic, their customers were left with a limited choice: digital banks and fintechs.
In an environment where physical and financial health concerns are increasing, solutions that integrate contactless payments with account activity monitoring are appealing.
CARES and SBA
As fintechs continue to make more financial products accessible through slick apps, making the use of these services stickier and more habitual, their further successes will depend on complex regulatory approvals. Indeed, one of the steps in that process is how policymakers and regulators embrace fintech solutions.
When the U.S. Congress passed the Coronavirus Aid, Relief and Economic Security (CARES) Act to provide financial support to small businesses through various programs in March 2020, financing was also distributed to fintechs, including PayPal, Inuit and Square.
This was an important policy decision. Even though these fintechs are not qualified lenders and cannot underwrite the loans themselves, they speed up the process.
The U.S. Treasury and the Small Business Administration (SBA) that administers these loans recognize the need for rapid credit processing in a crisis. Only a few small businesses in the U.S. have the financial capacity to withstand disruptions beyond two weeks. The faster the loans can be approved, the less likely that these businesses fail.
Fintechs offer an effective distribution channel, processing loan approvals in minutes compared with the hours, or even days, required by traditional banks. By sourcing funds from hedge funds or other investors, fintechs can deposit funding the same day for approved loans, thereby competing with banks themselves.
Although most fintechs are not set up to service SBA loans, many banks are now directing customers looking for SBA financing to fintech platforms that were designed for the loan application process; these platforms manage documentation supporting loan verification, including KYC/AML questions. They are therefore designed for seamless operational integration with bank systems.
It has not all been smooth sailing with the SBA-fintech loan application process. Though the process is mostly digitalized, fintechs still have to input some data from SBA loans manually, increasing processing times and operational risks. Moreover, the SBA loan system does not have the capacity to manage the onslaught of applications, leading to crashes as new financing becomes available.
These problems notwithstanding, it is clear that fintechs - with the support of regulators - have played an important role in expediting loan applications during the crisis.
DLT: A Potential Solution
Given the volume of loan documentation that needs to be collated to support credit decision, the management of the documentation is cumbersome, as anyone who has applied for a residential mortgage can attest.
Digital management of the loan application process is commonplace. However, the problems with COVID-19-related applications shine light on the need to further streamlining the process, particularly when financial information needs to be shared and distributed across various groups.
Clearly, SBA loan applications (among other loan application processes) can be further expedited through the use of distributed ledger technology (DLT). This technology can enhance processing, via eliminating delays and mitigating risks.
DLT serves many purposes in the credit evaluation and underwriting process. Theoretically, it can replace the physical processing of loan documents, integrate the credit analysis process (including the AML/KYC information verification), streamline the credit approval process, speed up funding (perhaps through a digital currency or ICOs making it near-to-immediate) and simplify the post-funding performance monitoring.
By design, DLT provides immediate transparency and information verification to all the participants (including providers, servicers and banks) throughout the credit underwriting process. This reduces redundancy and confusion. Moreover, credit decisions made with the help of DLT are less error-prone, thereby limiting operational and credit risk.
Although DLT has been around for quite a while, wide-scale commercial adaptation has been dragged down by institutional resistance. However, it is during periods of rapid change when existing technologies can be used to solve common problems.
Today, it's just a question of how quickly banks and loan servicers (including fintechs) will adopt DLT. The technology and the institutional components are there. Moreover, established protocols for document exchange and systems integration are in place. What is missing is the right push, at the right time - but that opportunity may be arriving shortly.
Don't Forget BigTech
Fintechs have clearly made significant inroads in virtual banking amid the pandemic, but they are not alone. Technology giants (aka "BigTechs") like Google and Apple are also making a strong push for their share of the digital banking pie.
Confirming long-time rumors recently, Google has deepened its banking forays beyond peer-to-peer digital payments, via the development of physical and virtual debit cards that it plans to co-brand with banks. Going head-to-head with the Apple Card, Google sets its eyes on the global card transaction business, where the Apple Card has quickly grabbed a sizable share.
In their pursuit of transaction-based revenue sources from financial services, BigTechs certainly hold some strategic advantages over traditional banks. For example, they have the benefit of direct access to immense depth of data harvested from consumer and business interactions; stellar, cash-laden balance sheets; an almost inexhaustible high-quality engineering talent pool; and knowledge of usage patterns.
Indeed, with their ability to accurately monitor, predict, price, and manage risks can undermine the inherent advantage banks have, and BigTechs could eventually make traditional banking obsolete. One of the ways BigTechs may achieve this in the long run is by spinning off their financial subsidiaries into fintechs.
It is hardly surprising, for example, that Ant Financial, the fintech subsidiary of BigTech giant Alibaba, is one of the largest fintechs in the world. In an effort to gain even more ground in their competition with traditional banks, more BigTechs may follow Alibaba's fintech example.
The risk of disruption is real.
In the banking community, fintechs and BigTechs have helped reduce the friction caused by social distancing, via offering easy, online access to loans and other financial services. In the unprecedented disruption that is unfolding in front of our eyes, the role they play is increasingly central.
As policymakers recognize the importance of fintechs, the regulatory resistance that has slowed down broader acceptance of digital banking may gradually yield.
Peter Went is a lecturer at Columbia University, where he teaches about disruptive technologies like artificial intelligence and machine learning, and their impact on risk management.