As part of our “Five questions on FinTech” blog series, I sat down with Ram Ahluwalia, CEO and founder of PeerIQ, to get his point of view on key factors affecting FinTechs, their challenges and what they should consider as they evolve, along with his perspective on the future of data and analytics.
Q1: What are the key factors affecting the FinTech industry today?
FinTech lenders today face several key objectives, such as acquiring customers at a low cost and maximizing customer lifetime value. But just as importantly, if not more so, is the ability to source the capital needed to fund those newly acquired borrowers at the lowest cost and from a diverse, resilient set of funding sources. Since 2016, the sector has been most impacted by the inability to acquire funding capital to meet origination growth. And the way platforms are accessing new capital sources is by building trust through independent data and analytics, pricing and valuation, asset review tests, enhanced disclosures, and data standardization—all of which greatly help in attracting new, low-cost, diverse institutional capital.
Q2: What are some of the critical milestones for the FinTech industry?
I think there are a couple key milestones or phases of growth for FinTechs. First, securitization activity has risen. In the last year, we’ve seen 60% year-over-year growth in securitization issuance, and we think that growth trend will continue going forward. Related to that, most securitizations are now rated, which has expanded the base of possible buyers of those bonds. We think that will become more necessary as platforms’ nation volumes continue to expand. Finally, we expect continued standardization of data and reporting for the industry. It’s very challenging for institutional investors and banks to price and compare the risk for multiple FinTech platforms. Standardization and normalization will help institutional investors and banks better compare, price and assess risk.
Q3: What are the challenges in managing risk?
There are multiple risk management challenges for the category. As initial context, the typical loans you see in the category are three- or five-year consumer loans, with each loan having idiosyncratic pre-payment and default behavior. Managing risk requires assessing a pool of loans, projecting defaults and pre-payments, generating cash flows then discounting those cash flows to understand the value or price of the loan pool. Or really, distributing prices under different macroeconomic scenarios. One of the big questions asked in the industry is: “How will these loans perform in a credit cycle or during a recession?” It’s very challenging to answer that question without data and analytics. Institutional investors need risk management tools to perform stress tests and project cash flows under various macroeconomic conditions.
Q4: How are investors, banks and FinTechs working together?
Institutional investors and FinTech lenders are collaborating in several ways. To frame it up, we’re in a negative real rate environment, and institutional investors are looking for short duration high yield, which is hard to find today. On the other side, you have FinTech lenders producing loans that provide credit to traditionally underserved segments, offering risk and return characteristics attractive to institutional investors. Institutional investors are buying these loans, as well as financing them.
Banks have access to cheap deposit funding, and online lenders are leveraging novel data sources, decisioning technologies, and unique customer acquisition channels. There’s a natural combination in pairing the low cost capital that a bank can provide with the unique, online customer experiences and origination channels that marketplace lender platforms offer.
Q5: What’s the next phase of FinTech growth?
FinTech lending has grown dramatically since its inception. It’s a global phenomenon driven by regulatory capital considerations and secular trends, and we think there’s more growth ahead of us.
To unlock the next phase of growth, there will be a focus on data and analytics. On the data side, we’re going to see more normalization and standardization in terms of how risk is represented. We’ll also see additional data attributes from alternative data sources to help institutional investors better project cash flows, losses, delinquencies and pre-payments. On the analytics side, we’re going to see innovation related to credit models to help project cash flows and see them from a default and pre-payment perspective.
FinTechs will also need to build trust with investors through enhanced disclosure, asset review tests, independent pricing evaluation and second-level verification. We think that’ll be a very important part to unlocking additional pools of capital to purchase these loans.