Why banks shouldn't make online banking too easy
In an effort to offer customers an Amazon-like experience, some lenders may be making it too easy for consumers to access financial offerings.
That is the argument put forth by an academic who says banks and other financial services companies must make customers consider the consequences of taking out a loan or signing up for a product.
His pitch runs counter to the current trends among fintechs, banks and other lenders, which are focused on making it easier for customers to sign up for accounts and obtain funding. But Sudheer Chava, director of Georgia Tech's quantitative and computational finance program, says it can be bad for consumers and businesses if customers don't have time to think about their financial health first.
"Friction is good in this circumstance because it makes the customer think about if they can afford the purchase," he said in an interview. "Impulse buyers don’t have the discipline to actually go through all the information. Even if the payment plan is say only $20 a month, they might not realize they are paying a high annual percentage rate."
Chava has taught a fintech class for roughly five years at Georgia Tech, sits on the steering committee of the college’s fintech accelerator and writes reports about Georgia’s fintech ecosystem, in addition to conducting his own research and industry consulting. When he began teaching at the university, fintechs seemed ready to disrupt banking and banks seemed worried about being displaced, Chava said. Over time, fintechs have partnered with banks and banks have made their own investments in technology.
“Through the years there’s been learnings on both sides,” Chava said. “Fintech doesn’t come exclusively from startups. Banks are innovating and incorporating fintech into their operations.”
But increasingly, Chava’s research revealed the negative impacts of fintechs on consumer lending.
For a recent research paper, “Winners and Losers of Marketplace Lending: Evidence from Borrower Credit Dynamics,” Chava and his doctorate studies students Nikhil Paradkar and Yafei Zhang studied more than a million consumers of a major market place lender. He found that some of the customers whose debt was consolidated by the marketplace lender ended up with a lower credit score and more debt outstanding than before debt consolidation.
Chava contends that both fintechs and banks need to be more aware of the effects of a more efficient process. Following is a transcript of the interview, edited for length and clarity:
How do you see fintechs changing financial services?
SUDHEER CHAVA: I like the focus on the customer, on reducing friction, on cutting cost, and making it easier for the customer, but I think one has to be careful. Many times I see fintechs that want to make the products instantaneous. They want you to be able to click a button, be immediately approved for a line of credit and purchase an item. In this frictionless world, you make it as easy as possible.
My view is that friction is good in this circumstance because it makes the customer think about if they can afford the purchase. Impulse buyers don’t have the discipline to actually go through all the information. Even if the payment plan is, say, only $20 a month, they might not realize they are paying a high annual percentage rate.
Where else should fintechs and banks be wary of removing friction?
Even in terms of a zero percent broker commission. A low transaction fee and trading on your phone is good for some people who have knowledge and are disciplined, but there might be people who trade too much because of lack of friction. We know from a lot of research that when people trade too much, they lose money. It might not be good for their financial health because they overestimate their capabilities and are trying to time the market.
Do fintech startups have enough disclosure around their business models?
Like any startups or innovators, they’re quick to jump the gun. They sometimes don’t get all the necessary regulatory approval or don’t disclose all of the necessary information, which is what comes back to bite them. A lot of this comes with cost, from know-your-customer to anti-money-laundering to any kind of Bank Secrecy Act. So they sometimes try to do some kind of regulatory arbitrage in a way.
Do you think each fintech should disclose how it monetizes its business?
It’s a conflict of advantage, so they can’t disclose everything. But to the extent that a fintech is sharing information and monetizing information about consumers, then the consumers have a right to know about how the fintech is doing that. That comes with any kind of company that collects data on users. Since the consumers are in a way paying for that, they should disclose that.
How much should they disclose about how a depositors money is insured? Should they disclose the details of bank partnerships if they don’t have a bank charter themselves?
That disclosure is more important than disclosing how they monetize data. Because here there is a real risk that the consumer might lose their money and it’s a safety issue. Anything involved with the safety of the funds for the consumer, it’s extremely important for them to be as transparent as possible and disclose as much information as possible. You want to understand in what cases the insurance will pay for the consumer and in what cases it might not.
What’s been the largest impact of fintech-led disruption?
If one looks around 25 years back in the U.S., the small banks used to originate a large portion of consumer lending. But with technology, the big banks have been able to invest in technology and have taken the majority of consumer lending. Fintech is not a displacement of banks, but it’s the next step in the evolution of banking.
What’s your latest research about fintech?
I have a recent paper that I put to the Office of the Comptroller of the Currency. The big thing about this paper is the winners and losers of marketplace lending. We got access to the data from a credit bureau, so we can’t disclose the name of the bureau or the name of the fintech company we looked at.
We looked at the borrower credit dynamics of borrowers who borrowed on the marketplace lending platform. We found that when credit card debt is consolidated, consumer balances go down immediately. Over a period of time it starts creeping up and they are back where they are a year down the line. The net result is they have debt from the installment loan in addition to the credit card debt and higher debt outstanding than before.
Their income hasn’t changed, so they are much more likely to default than before. What we tried to do is match each borrower that had used a marketplace lending platform with a borrower that had not, but had a similar credit score, trends with credit score and lived in the same neighborhood with similar socioeconomic characteristics. Both borrowers were similar in all dimensions and both got declined from a traditional bank initially.
What we find is that in the process of taking debt from a credit card and shifting it to an installment loan from a marketplace lender, this borrower has a better utilization rate and balances. The borrower sees a jump in credit score because it looks like the debt has come down. There’s a jump in the month afterward and three months down the line the credit limit from the bank starts increasing. The same bank that didn’t give them credit before is giving them more credit now.
But these borrowers draw down on that credit in the same way as before. It causes borrowers to jump from subprime to near-prime and from near-prime to prime, and they start to increase in that credit line. Fundamentally the financial institution hasn’t changed.
What has to be done to avoid that?
Financial education. The fintech is consolidating debt but also giving them information about keeping debt down. Providing more information and not putting it in a bullet point or footnote, but making them understand through small graphics and case studies so consumers might know what's troublesome. Focus on advising the customer in a way that they are using debt wisely.
From the point of view of the banks, it’s important to not only look at the level of debt the person has, but also look at the trends of debt. Look at how much debt they had and how they got there. Banks also need to not rely just on credit scores and need to ask why consolidation happened.
Bankers especially have to apply the same prudent policies to loans they acquire through a fintech lender as they do to loans they originate themselves.