February 2, 2015

Innovative startups focus on lending algorithms

A handful of innovative banking startups have been working on creating lending algorithms that consider more than the traditional variables such as one's credit score. Amid this push, companies are developing risk evaluation methods that account for how much time an applicant spends reading terms and conditions or whether they only use capital letters when filling out forms, The New York Times reported.

Widespread benefits
Advocates contend these creative approaches could result in widespread benefits, including more accurate risk assessment, according to The New York Times. This development could spur a wider market for lending and also reduce borrowing costs. Rajeev Date, who previously worked as a banker and as deputy director of the Consumer Financial Protection Bureau, emphasized that these algorithms could result in billions of dollars in savings.

Borrowers are not the only ones who could potentially benefit from this shift in the lending industry, as these innovative startups have drawn the attention of investors, major banks and credit card companies, The New York Times reported.

Lending Club
As market participants have grown increasingly interested in new approaches to credit, Lending Club, the world's largest peer-to-peer lender, raised more than $1 billion in its December initial public offering, according to Bloomberg. During the first day of trading, company shares surged 56 percent, pushing the online lender's valuation to nearly $10 billion.

OnDeck, an online lending platform, followed suit soon after, raising $200 million in its IPO, Bloomberg reported. Michael Brown, a general partner at Battery Ventures, predicted that after LendingClub's primary offering, investors would be open to OnDeck's sale.

Many heralded the LendingClub IPO as a watershed event, taking it as a sign that the entire peer-to-peer lending industry was taking off.

Broad market potential
While LendingClub and OnDeck have shown that larger players can hold successful IPOs, startups such as Affirm, which provides borrowers with alternatives to credit cards for their online purchases, as well as Earnest, which uses data science tools to make personal loans, have jumped in to this burgeoning industry, according to The New York Times.

They may have access to a very broad customer base, as estimates from the National Consumer Reporting Association reveal up to 70 million Americans have either no credit score whatsoever or very light credit history that provides them with a low score, The New York Times reported.

How banks can profit
As the lending industry undergoes rapid change, banks may have a hard time writing algorithms quickly enough to keep up with more nimble firms. However, they can profit from the shifting landscape by forging partnerships with innovative startups.

When determining who to work with, selecting the right partner is crucial. Banks can greatly increase the odds of finding the right partner by working with Garnet Capital Advisors, a loan sale advisory firm with substantial experience in the banking industry.