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Is Fintech The New Subprime Crisis?

|Includes: LendingClub Corporation (LC)

If it continues in this way then its progress cannot be sustained.

It currently focuses on irrelevant matters

Fintech has to change its focus to solving complex global challenges

The short answer is yes. I have been watching the ascent of the Fintech industry for a number of years now and at first I was excited about this upstart industry that is presenting a credible challenge to banks and other financial institutions who have not acted with prudence and endangered the global financial system.

My thinking has always been that the finance is a public service therefore banks and financial institutions have to conduct themselves with a greater level of trust and integrity. Furthermore, they must always accept that they will be subject to a greater level of control and scrutiny in the public sphere simply because their activities are so vital to the public good.

Therefore managers of financial institutions must always remember that they are trustees of public finances and therefore conduct themselves accordingly. I am heartened to see that a new generation of managers in financial institutions globally are taking this approach especially in emerging nations.

In these emerging nations, banks and financial institutions are taking more responsibility in supporting their government’s development goals, they have become trusted partners to governments and NGO’s. This is indeed a welcome development.

Having said that, we return to the subject of Fintech. As someone very involved in private equity and so on, I have heard about the various innovations in Fintech and the associated bitcoin or cryptocurrencies revolution.

We even hear of many traditional investors including Mark Cuban seeking to raise money through an ICO or initial coin offering, I find myself asking what the point of this is. It feels very much like the beginning of the end of a Fintech movement that has lost its focus and strategic aims.

While the aim of this blog is not to speak about the relative merits of bitcoins, cryptocurrencies or indeed Fintech as a whole, I will suggest that this is not where Fintech as a whole needs to be going but rather it needs to take its unique abilities to unlock complex global financial challenges.

Bitcoins and all other payment architectural products have become seriously overrated especially as many new entrepreneurs have come into the industry not to make a difference but are attracted to the large amounts of money that can be earned.

It becomes even sadder when you begin to look at the shareholders of most of the leading Fintech companies, one will then realize that most of their investors are the very banks that they are supposed to disrupt out of business.


Rather they have become the vehicles banks use to take on the risk that they are not allowed to take themselves, in essence they have become vehicles of subprime loans and they spread these risks across the global markets through crowd funding structures.

It has become abundantly clear that Fintech is fast becoming irrelevant and a sad caricature of itself as it is does not solve any real global challenges instead it busies itself with solving non problems such as a person can make payments through a phone ‘big deal’.

Most Fintechs are primarily about paying more efficiently and borrowing money. In a global macro environment where debt levels are already at eye watering levels at the personal, corporate and government levels then this is very unwise.

It is my belief that new entrepreneurs in all business areas need to ask themselves the sustainability question which is ‘when this business grows, does it add solutions to the world or more problems’.

Fintechs who focus on loans are creating more global problems than solutions. I fear for the future of Fintech because when an individual or a business is facing financial challenges and has a choice to pay the conventional banks which holds their collateral or pay for their Fintech loans, most people will pay for their bank loans and default on their Fintech loans.

We are still in the ascendancy stage of Fintech which gives us an opportunity to correct the long term direction in this industry, the chart below is typically what investors looks at when deciding to invest into Fintech.

As we can see, it looks very attractive especially when extrapolated up to 2020 but a major problem is the short time span on which the data is based. Anything can look good in the short term but in the longer term, we begin to the cracks and we have not yet seen a real test of the Fintech Industry particularly online lending to determine its strength in depth.

In 2008, I remember many suggesting that the models used for the creation of the models used to entice investors to buy the mortgage assets covered a very short time period because the tendency of investors in general is a very short term outlook especially in these days with modern communication, it is very apparent that investors are making the same investment mistakes that they have always made which is to enter into a market trending higher and buying into it when all the time, it was the original investors or insiders who are pumping up the assets with their own money and then when they have made enough, dumping the assets and it crashes and takes with it many lives around the world.

Old Woes Continue to Hang Over Lending Club

I know investors both large and small who have invested significant amounts of their net worth into these programmes. This system will explode very soon and this time it will be worse because it is not simply restricted to the financial institutions like in 2008 with the rest of suffering from the effects on our daily lives but rather this time it will be catastrophic for small and large investors alike.

In most of these loans, it is the buyer of the loans that carries most of the risk followed by retail investors and institutional investors who have shares in the Fintech but in many cases, the founders and original investors have already made their money through IPOs and private sales of shares.

Part of what makes this model such a problem is the wrong advice that is given to prey on the ignorance of the majority of people in relation to their finances. I know one company who suggests to its investors to invest in a wide range of these small loans to diversify and reduce risks of suffering losses.

This is extremely bad advice at its best and fraudulent at its worse because any person with experience in investment knows that you do not reduce risk by investing in more of the same asset, rather you just continually increase your exposure and risks because the underlying drivers of any assets are the same, they are all subject to the same conditions and react broadly the same to external conditions therefore risk is not reduced but increased.

We are all familiar with the problems banks are having with NPLs (non-performing loans), giving loans is not an innovative business model that the Fintech industry make it out to be, banks reduce their losses by a whole host of prudential regulations which provides checks and balances to their ambitions.

Furthermore, bank depositors have access to various compensations schemes however inadequate they may be and finally banks take collateral to limit their liabilities, I know of no Fintech companies that have these structures built in and this is why Fintech companies are faster and more efficient than banks because they are not following wise principles of lending and are far more risky than they portray themselves.

Algorithms cannot predict if a person will pay their loans or not, many banks have tried this and it does not work. There is no substitute for wise loan officers, credit committees and a prudent system for giving out loans.

On the other hand, banks have argued that increased regulations forces them to retrench and therefore lend less money. I may be in the minority when I say that regulations are a good idea. I remember in my first year of law school, we had a constitutional law class and the professor gave a quote attributed to Sir Thomas More in the 1966 film of ‘A Man for all Seasons’ when he had a discussion with William Roper.

The discussion went like this-;

A Man for All Seasons (1966)

Margaret More: Father, that man's bad. 
Sir Thomas More: There's no law against that. 
William Roper: There is: God's law. 
Sir Thomas More: Then God can arrest him. 

William Roper: So, now you give the Devil the benefit of law! 
Sir Thomas More: Yes! What would you do? Cut a great road through the law to get after the Devil? 
William Roper: Yes, I'd cut down every law in England to do that! 
Sir Thomas More: Oh? And when the last law was down, and the Devil turned 'round on you, where would you hide, Roper, the laws all being flat? This country is planted thick with laws, from coast to coast, Man's laws, not God's! And if you cut them down, and you're just the man to do it, do you really think you could stand upright in the winds that would blow then? Yes, I'd give the Devil benefit of law, for my own safety's sake! 

If we cut down all the regulations and sacrifice them on the altar of profits, who protects us when the institutions that have been empowered through deregulation and global treaties begin to threaten and take advantage of all of society not just the most vulnerable.

This current season of mass deregulations is very dangerous for stakeholders of the financial industry through our deposits, savings insurance products, pensions and so on. Many complain that banking regulations makes banking boring but this is what we need, boring stable banks that build their business brick by brick rather than unstable Fintech whose houses are made of straw.

To highlight the differences even further, I will tell the story of a story Jesus told in the Bible. He spoke of two men; one built his house on the rock and the other built his house on the sand. The house which was built on the rock was understandably harder to build and took much longer while the house built on the sand was built much faster.

When the rain and the storm came, the house built on the sand fell while the house built on the rock stood firm. In the same way, investors have to ask themselves whether these are investments built on the rock or on the sand. Investments built on the rock are sustainable over the long term as they add value to society while those built on sand are always shifting and will eventually be washed away and buried in the quick sands of time.

This is why we are advocating a New Global Financial Model that represents sustainable investments that is concerned with building people, communities and development structures over the long term.

New Finance is concerned with putting more money and assets into people not just their ideas, making finance work for the majority as well as the minority. Most of the innovation and breakthroughs I hear about in Fintech including these much vaunted ICO or initial coin offerings do not go close to meeting the requirements of New Finance.

Having lived in both developing and developed nations, I can safely say that in developing nations and increasingly in developed nation, the concern is not which method to use in paying bills or buying shares in dollars or bitcoin but rather the concern is school fees, funding old age, accessing agricultural credit, getting clean drinking water and stable electricity, how to pay for schools and hospitals and finding good professionals.

While in the developed world, there are a number of other challenges as rising poverty levels and inequality is growing even in the Londons, New Yorks, Tokyos and LAs of our world today not just the Abidjans, Mumbais and Kievs.

These are serious questions that the financial industry especially Fintech has to answer rather than competing in markets where it does more harm than good. I have very good friends who are using Fintech to transform nations in emerging markets and this is what excites me and not crowd funded consumer loans.

In conclusion, going back to the question of whether Fintech is the new subprime, the answer is mostly yes but it still has a chance to rewrite its own story and become relevant again.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.