The economy is in shock. So hard, transactional data is falling just as banks need to make a lot of quick and difficult lending decisions for small to medium enterprise (SME) customers. Meanwhile, online data generation by consumers is rocketing. Can ‘alternative’ data help financial services firms navigate the current economic storm?
Between 9 and 22 March 2020, 44.6% of UK business saw a fall in turnover, according to the Office of National Statistics (ONA). That number is expected to get grimmer – despite government interventions to support payments to staff and business liquidity.
Struggling firms will need support from banks, but banks may find it hard to assess a firm’s prospects without current financial data. To make things worse, this is not just about individual companies.
In response to the economic pinch many firms are cutting back. So data on suppliers and customers could also be misleading when it comes to longer-term projections.
A wide range of data
Not all businesses are suffering. US sales of ‘alcohol, tobacco e-cigarettes and weed’ grew by 24% in the week beginning 3 March, for example, according to data firm Signifyd. That followed a 17% increase in the previous week.
It won’t be a revelation that goods that can be sold online – and that offer some relief from anxiety – are the current sweet spot. But there are other, less obvious trends.
US sales of electronics fell 39% in the week beginning 3 March, for example – at a time when many people might be expected to invest in a home office.
Knowing your customer
Transaction data remains the best measure of how a bank client will deal with money. Buying weed online during a lock-down may be a financial red flag, but it may not.
Large platforms that collect a great deal of information from many different sources – platforms like Tencent and Amazon – can carry out extremely insightful analysis.
However, as the recently announced collaboration between Amazon and JPMorgan suggests, models based on alternative data still benefit from cross-reference to actual financial transactions.
Firms such as LendUp and Zest, for example, which use alternative data to credit score those excluded by mainstream providers trained their algorithms by making ‘seed’ loans.
After all, though a family cutting back on meat and turning down the central heating may well be a good indicator of financial stress, it could equally be an indicator of a greater focus on health and sustainability.
The challenge for all firms that use alternative data to model likely financial behaviour is deciding which signals, and in what combination, are predictive. A tendency to swipe hard on the screen of a smartphone may well show that someone is more likely to be hot-headed.
The question is whether that can predict defaulting on a loan. That sort of call becomes particularly challenging in a crisis.
A fintech shake-out
The vast amounts of data that big technology companies can gather gives them a very deep and broad view of the economies in which they operate. They also have economies of scale. All in all, they are expected to make a big impact on financial services if they decide to compete in that segment.
Governments globally want to see more competition in banking – particularly following the 2008 financial crisis. There are question marks, however, over the survival of some smaller fintechs.
Charlotte Crosswell, CEO of Innovate Finance, said on a Westminster Business Forum webinar in April that not all regulated fintechs have access to the Bank of England's discount window in the current crisis.
At the same time, most fintechs cannot raise fresh capital from rattled investors and their turnover is down. That means some could find themselves running out of cash. All of that is before they wrestle with an inverted yield curve.
Another speaker on the Webinar, Kevin Chong at Investec, called for a co-investment fund to bailout UK fintechs. This would ensure that the efforts to boost competition in the UK’s banking market are not undone by the crisis.
What next for fintechs and the use of alternative data?
The Bank of England has not said whether it might try to ease the pressure on some fintechs. Fintech banks, including Monzo and Starling in the UK, have furloughed staff in the crisis.
However, that does not mean that fintechs – and the competition they bring – will go away.
It is a very challenging environment even for large, established players. Nationwide, for example, has announced that its plan for entering business banking is “no longer commercially viable” because of Covid-19 and “short and long-term interest rates”.
However, Covid-19 is expected to permanently change a number of aspects of the UK economy – not least the way that the UK makes payments.
“I think it will,” says Graham Mott, Head of Strategy at LINK, which runs the UK’s ATM networks. However, Mott stresses that the crisis also shows how important multiple and resilient systems are. Cash, for example, doesn’t need special systems to be in use.
By the same token, it seems likely that the government will want to ensure that alternatives to the big banks – and alternative approaches to finance, which became a priority during the last crisis – also survive.
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