Discuss the huge challenges posed by algorithms to the Fintech sector which might lead to another global financial crisis.
As per the Journal of Economic Behaviour & Organization, the rate of defaults on loans intermediated by financial technology platforms have risen sharply in the last few years. It has been mainly identified to be caused by the algorithm based lending in the Financial sector and is expected to bring an end to the booming Fintech if uncontrolled.
Reasons for rise in default of loans through algorithm based lending:
- Reliance on alternate data:
- Unlike conventional bank lending, It primarily uses the alternate data – data from shopping details, phone details, bank message details and investment details gathered through Account aggregator.
- Evergreening of loans:
- Since the algorithm based lending is based on the quality of repayment of earlier loans primarily, without scrutinizing the manner in which the repayment is made, it is leading to approval of profiles who are repaying their earlier loans with the money from newer loans specifically taken for payment of the earlier loan. This inability to track evergreening might eventually lead to a huge cycle of non repayment of loans.
- Zombie borrowing:
- Manipulating the algorithm set up to borrow more loans to repay the earlier loans will lead to higher rates of defaulting in the long term, referred to as the zombie borrowing.
- Selective labels problem:
- The factor of being cleared by one fintech platform or in association of one fintech platform increasing the possibility of accessing facilities in another fintech platform and leading to easy disbursal of loans might lead to poor recovery.
- Soft information:
- In conventional banking, the direct interface of creditor and debtor increases the possibility of getting to know more about the borrower beyond numbers. The character assessment, an important factor in repayment of loan, is possible in conventional lending but not so in algorithm based lending.
Inevitable in Banking sector:
- In spite of such challenges, the utility of algorithms in Fintech is beyond replacement.
- New-age fintech lending startups are dominating the personal loan market with a 76% market share in terms of the number of loans issued, according to data released by the Fintech Association for Consumer Empowerment.
- Striving for a cashless economy, it is inevitable to not pursue algorithm based lending in Fintech.
Way forward:
- Extension of filtration through the algorithm tech with much emphasis on the nature of repayment of previous loans to avoid evergreening and zombie borrowing.
- Increasing the efficiency of regulation on Fintech to improve the quality of loans disbursed.
- Protection of consumer data across multiple financial platforms.
Source Indian express