The American financial system is broken, especially for the little guy.
People who want to start a small business, such as landscaping or becoming a notary, need starting capital. Banks don’t loan small amounts because they don’t make a profit, thanks to heavy regulation, so there is currently (by some estimates) 40-60% of the American population that is under-banked.
It’s not that banks don’t want to take the risk either. The 2007 financial crisis is evidence that banks are willing to take on a great deal of risk, but the rules have tightened as well. That’s why so many millennial buyers can’t get a mortgage until their thirties. The capital they need is locked up, because the Federal government has placed certain thresholds following the crisis.
The intention of this legislation was to create a safety net that the Fed felt would free banks up to lend more money. Instead, banks held onto this safety net and made very conservative investments. The solution isn’t to de-regulate in every case. FinTech startups may prove to be a valuable piece in this puzzle.
Straight Talk on Lending
Banks prefer to make deals they know they will get paid on, so anyone with poor credit or high debt presents a significant risk. That is a massive opportunity for individuals with money to loan. One remarkable change that has occurred in the past decade has been peer to peer lending. Individuals are able to assess the credit of a borrower, and form a risk profile. The amounts being leant are relatively small, so the risk is substantially reduced. $500 might not be much to someone making $75,000 a year, but for someone starting a business it means equipment or paying for a service they need.
Other Challenges
A great deal of money is moved digitally these days, and there are often gaps of time where the payee has to verify the funds have been transferred. This hurts consumers living paycheck to paycheck, who rely on up-to-date information to make their purchases.
If you’re making minimum wage, the difference between buying yourself lunch one day and paying for gas in three days is a very real conundrum. Many people face this crucial decision every day, and failure to monitor money can result in all kinds of problems. If they miscalculate and aren’t able to pay for gas, they can’t make it to their job. That can hurt them in other ways, making them look unreliable or irresponsible, potentially hurting future career prospects too. There is also the problem of overdraft fees, which is akin to charging interest for banking. That fear drives people away from banks unwilling to work with them.
Banks cannot respond to this by themselves. It’s easy to forget, because of the digital revolution in finance, that banks are not technology companies. Mint managed to fulfill some of this gap when it was founded in 2006. Providing a dashboard for finances became so valuable, the company was acquired by Intuit in 2009 and has flourished since.
What Liquidity Really Means
For those at the bottom, liquidity means knowing what you have on hand that you can spend, and being able to forecast your margins effectively. Much of this work is already beginning to happen on the smartphone, a device most people have universal access to. More and more, people will begin making mobile transfers, checking balances and making purchases from a device they carry in their pocket.
The challenge moving forward is for FinTech startups to search for solutions to these problems. Loans with shorter terms that cater to riskier borrowers are in higher demand year after year. We need fewer digital wallets and more solutions that cater to realistic needs of those at the bottom.
Banks can do their part by helping to fund sandboxes for these FinTech startups to experiment safely. Citi Group has already seen this reality firsthand, acknowledging that it’s too much of a slow-moving beast to respond to these new demands from the market. Instead, they look for smaller, more agile firms to inject investment cash and give them opportunities to grow. That kind of investment is crucial to the middle class of America, and will have tangible results on the financial future of those at the bottom.
Phin Upham, AKA Phineas Upham, is a technologist and adviser for Harmoney. Upham also works for Thiel Capital, and was a guest speaker at the Milken Institute. If these ideas interest you, the Milken Institute talk is a great opportunity to learn more.
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