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Looking beyond FICO: innovative fintech startups in risk management

Prodigy Finance - November 07, 2014

Looking beyond FICO: innovative fintech startups in risk management

Startups and technology are disrupting financial services in a myriad of ways that benefit consumers.

In this two-part series, we review some of the most exciting “fintech” (financial technology) startups. This post will focus on startups that are revolutionizing credit risk scoring, either in collaboration with or to compete with banks.  The next post will look at startup models that attempt to replace core retail and investment banking functions. And if you’re interested specifically in P2P crowdfunding, check our previous blog coverage on that topic, here.

Why risk management?

Whenever banks or other institutions give out loans, credit cards, or even debit cards, the institutions assess the risk that the customer will default or overdraft. When banks are too trusting (or, in some cases, irresponsible or incompetent), they give out loans to people who can’t repay; defaults result, and investors suffer. When banks are too conservative, they don’t give out enough loans or price them at exorbitant rates, hurting individuals and small businesses.

The problem is, it’s hard to assess risk perfectly. There are major information asymmetries involved: you, as a loan applicant, may know how creditworthy you are, but the lending institution does not, and it doesn’t know whether to trust you when you claim you are.

To solve this, banks rely on credit reports to assess risk. But credit reports have their own problems: they’re based on limited data and don’t help new entrants to credit (e.g. recent graduates or immigrants). Earlier this year, our CEO Cameron identified ways the old-school credit bureau report could be improved.

So what are startups doing differently in risk management?

1. They rely on social media

Social media may reveal a great deal about its users, upon which lenders can capitalize.

Neo assesses automobile loan applicants by looking at the number and nature of Facebook and Linkedin contacts, as well as borrowers’ social media content (posts, photos, likes). The founder told The Economist last year that “within a year there will be enough evidence to determine if making racist comments on Facebook is correlated with a lack of creditworthiness.” Based on the newest iteration of its website, the startup may be pivoting to include other data sources too.

Hong Kong-based Lenddo uses similar methods, as well as asking contacts to vouch for the creditworthiness of loan applicants. The company currently uses this social media data to underwrite small, short-term loans in Mexico, the Philippines, and Colombia. (The average loan in the Philippines is about the size of a one-month paycheck and must be paid back in 9 months).

2. They use mobile phone data

Mobile operator Safaricom is famous in East Africa for year ago introducing MPesa, a now-ubiquitious mobile banking service. In 2012, it introduced a sister product, MShwari, a credit/loan and savings service. The idea is simple: airtime top-ups and mobile data can be rich sources of information about client creditworthiness—particularly in areas of the world plagued by thin data on historical consumption. Since then, other start-ups, notably First Access Markets, based in New York, have jumped on this bandwagon.

3. They aggregate disparate sources of data

Aire, part of this year’s TechStars Barclay startup accelerator programme, aims to consolidate a set of new data sources to determine creditworthiness. Much of this data is self-reported, with some limited verification (e.g., using Linkedin to verify your career information).

Credit Benchmark takes a more institutional approach: it pools credit risk estimates and data from multiple banks and benchmarking resources, while guaranteeing anonymity for its data contributors.

4. They leverage the employer

Even in the absence of credit history, loan companies can work with employers to leverage monthly paychecks for repayments. This is precisely what new South African startup Creditable does, by appealing to companies to support their employees’ financial stability and happiness by providing manageable wage advances or loans, using the Creditable platform. 

We’re excited to see how risk management transforms in the next few years, and will keeping an eye on how to make sure our own innovative methods take advantage of what works.

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