April 28, 2016 By FTI Consulting
Having spent a couple of decades working in the trenches of financial services, I can say that one learned behavior yet to leave me is to always keep an eye on what Goldman is doing.
This is not to say that Goldman was always right (they did, I note, help themselves to multiple billions of dollars from the government during the financial crisis without too much protest) but they are often right, and there don’t seem to be many half measures taken at 200 West Street.
And so, I have to say, I find it remarkable, absolutely remarkable, to read that Goldman is entering the consumer credit business.
I admit to not paying a ton of attention in May when the firm hired Harit Talwar, the former Discover Financial Services executive, to head an “online lending effort” – if anything, I figured this might have been an oblique ability to better understand, or maybe even bank, the FinTech sector (a sector that the outcome of the LendingClub IPO made tough to ignore).
But they’re in the mainstream press now, with a long article last month in the Grey Lady talking about how the firm will be making small-scale loans to consumers and, potentially, small businesses via a website, or an app.
Developing an app to broadly offer a service is hardly revolutionary, certainly, and there are a number of dismissive criticisms offered, including one sell-side analyst at Oppenheimer who’s quoted saying, “I refuse to believe that hiring a couple of programmers and offering to make $15,000 loans online is a highly value-added banking strategy.”
So who’s right: Goldman Sachs, or an equity analyst (interestingly, himself a member of an archaic financial services business model that is completely on its heels – providing research for free, hoping for commissions, in a viciously competitive business that has been commoditized to the penny).
Not for nothing, but I know which horse I’m betting on.
I’ve written about the business of consumer lending before but in my mind the revolution in lending isn’t really in the delivery of the service (i.e. an online or app-based process) – the revolution is in how the lending decision itself is made.
A colleague of mine passed along a recent article in VentureBeat dissecting a patent application from Facebook that shows how a technology they have developed will allow users to be evaluated within the context of their network – from the patent application:
“When an individual applies for a loan, the lender examines the credit ratings of members of the individual’s social network who are connected to the individual through authorized nodes. If the average credit rating of these members is at least a minimum credit score, the lender continues to process the loan application. Otherwise, the loan application is rejected.”
The thrust of the VentureBeat article is that this second order evaluation is “questionable” as a basis for evaluating a lender’s ability to repay, but let me raise the contra point – is it?
What if it turns out that as a determinant, a person’s digital and social presence and community is a perfectly valid, perfectly accurate, way to asses credit risk?
In fact, evaluating an individual’s risk based on the composition of a particular community they belong to is hardly new: decades ago, as a college student with no income and plenty of debt – on paper, a terrible credit risk – I’d have to wade through dozens of credit card applications every time I opened my mailbox.
This is because Visa wasn’t lending to me per se. It was lending to potential college graduates en masse, and all of the evidence their actuaries came up with said “forget about whether the one guy has any money, look at the company he keeps – statistically speaking, he’ll pay his bills.”
If anything, it is surprising that it has taken as long as it has for lenders to begin to wonder what implications the digital company we keep has with regard to our creditworthiness.
Traditional credit scoring is limited at best, deeply flawed at worst – as evidence I’ll simply point to, say, the last 7 years of global economic misfortune. There was a ton of consumer credit analysis done by 2008 – it just turns out to have been an imprecise predictor. What is incredible is that, with few notable exceptions, standardized consumer scoring models are largely the same now as they were then.
Goldman’s foray into consumer finance, if I had to guess, is very unlikely to be based solely on a sleek website. Rather, I expect that Goldman has begun to internalize the sort of groundbreaking thinking that smaller, technology-driven FinTech companies are doing around evaluating credit risk (I think the people at Affirm are a terrific example of this).
So I’ll have to disagree with the analyst at Oppenheimer in terms of the potential of the opportunity here.
But I will friend him on Facebook, because I bet he’s got a decent credit rating, and maybe that will help me refinance my mortgage some day…