Thursday, January 10, 2019

A wave of the tech giants making inroads into the banking business with data tracking algorithms

See A $150,000 Small Business Loan—From an App: Square and other tech firms are jumping into banking, using their vast troves of data to determine creditworthiness by Peter Rudegeair of The WSJ.

Economists say that banks are financial intermediaries. They bring savers and borrowers together. But so are these tech companies that process customer payments. It allows them to learn how good a credit risk the businesses are since they know what there sales are.

"Last week, the San Francisco company took another step towards banking: It filed paperwork to open its own bank in Utah that would make loans to small businesses and offer deposit accounts to both companies and the general public.

Few things terrify today’s bank CEOs more than the specter of a big technology company elbowing them aside. Square’s new push puts it at the forefront of technology firms aiming to challenge banks not just on payments or digital apps but on the banks’ core business of making loans. Tech firms’ vast troves of customer data can give them a built-in advantage. PayPal Holdings Inc. has extended more than $6 billion in small-business loans since 2013, using data it collected by processing payments for Internet retailers. Over the past seven years, independent merchants that sell goods on Amazon have borrowed more than $3 billion from the e-commerce giant, which approves loans based on sellers’ historical volumes, Amazon reviews and other factors.

Older tech companies and financial firms have recently jumped into the fray. Last year, Intuit Inc. started offering loans to businesses that use its Quickbooks software based in part on the data contained in their accounting statements. First Data Corp. now lets businesses that use payments devices from Clover, a Square competitor that it owns, take out loans based on their sales history.

A team of techies at Square dreamed up its lending program, now called Square Capital, in 2013 when Square was around four years old. Their cumulative work experience in the financial industry was little more than a single yearlong stint at Goldman Sachs Group Inc.

Customer feedback drove the idea. Small-business owners that used Square’s payments services complained they couldn’t get bank loans, either because their personal credit scores were too low or their businesses didn’t generate enough revenue. Square Capital has since extended more than $3.5 billion in loans and cash advances to small businesses."

"It extended about 200,000 business loans in the 12 months ending Sept. 30—more than three times the number of loans banks provided through the entire Small Business Administration over the same period. But the average size of its business loans is about $6,500, much smaller than what banks typically offer."

"Square loans are funded by money managers, and if they decide to stop purchasing the credits, Square Capital would have to slow down its lending. To keep those investors happy, Square Capital also has to charge higher interest rates than banks, which are funded by low-cost deposits."

"Square is trying to achieve a delicate balance of offering banking services without triggering bank-level regulations."

"The bank that Square wants to open would be classified as an “industrial loan company,” a niche type of financial institution that can offer banking services without oversight from the Federal Reserve."

"Square makes automated decisions about riskiness by leveraging its data trove of businesses’ credit-card transactions. Square also looks at more detailed information, like whether a business is attracting repeat customers."

"Most customers never have to fill out a formal application, and Square can deduct repayments from a company’s daily take.

To offload risk, Square sells the bulk of its loans to outside investment firms."

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