The lending value chain: who does what in a fintech loan

Four parts of the chain

A BIS and World Bank paper on fintech and the digital transformation of financial services describes the financial services value chain as four broad components: the customer interface, back-office functions, infrastructure and the balance sheet. In lending, they can be read as follows.

• Customer interface. Where the borrower finds the loan, applies and is told the answer: a branch, an app, a shop's checkout, an employer's payroll system.
• Back office. Identity checks, the credit decision, servicing, collections and complaints.
• Infrastructure. The core lending system, payments, data connections and credit bureau links.
• Balance sheet. The money that is lent and the capital that absorbs losses when borrowers do not repay.

Unbundling and rebundling

A traditional bank does all four parts itself. The same paper notes that advances in information and connectivity have led to an unbundling of how financial services are consumed, and that the production chain could become more disaggregated. In lending, this means one firm can run the app, another make the credit decision and a third hold the loans. It also observes that, after driving this unbundling, many fintechs have begun to rebundle, adding new products themselves or through partnerships and platforms.

For a lender, the practical point is that a fintech loan is often a chain of contracts between several firms. Each link decides who answers to the borrower and to the regulator for that part of the work.

Fintech credit and its main models

A joint report by the Committee on the Global Financial System and the Financial Stability Board defines fintech credit as credit activity facilitated by electronic platforms, whereby borrowers are matched directly with lenders. It describes several models, which differ in who originates the loan and who bears the credit risk:

• Traditional peer-to-peer. The loan contract is between the borrower and the investors, not the platform; the platform earns fees, for example for account set-up, loan origination and ongoing repayment.
• Notary model. A partnering bank originates the loan, which is then sold or assigned to the investors.
• Guaranteed return. The platform operator guarantees the investors' principal, interest or both, so the credit risk is effectively shifted to it.
• Balance-sheet lending. The platform originates the loans and keeps them on its own balance sheet.

Follow the loss: a worked example

Where the platform earns fees and others bear the losses, its income grows with the volume it originates. The joint report notes that, under such an agency model, platforms rely on approving new loans to generate fee revenue. A simple way to see the incentive is to write the platform's result in each model.

Fee model: platform result = fees on loans originated − operating costs. Balance-sheet model: platform result = interest and fees − funding cost − credit losses − operating costs.

Example, with illustrative numbers: a platform originates 10 million dollars of one-year loans and charges a 3 percent origination fee, which brings 300,000 dollars. If 5 percent of the amount lent is lost, that is 500,000 dollars. In the peer-to-peer model the investors bear the 500,000 and the platform keeps its 300,000 of fees. In the balance-sheet model the same 500,000 falls on the platform itself. Same loans, same borrowers; the model decides who feels the loss, and so who has the strongest reason to say no.

How large, and where

A BIS working paper estimates that fintech credit reached 223 billion US dollars and big tech credit 572 billion in 2019. China, the United States and the United Kingdom were the largest markets for fintech credit, while big tech credit was growing fast in China, Japan, Korea, Southeast Asia and some countries in Africa and Latin America. These are 2019 flows of new lending from one database; what matters is the pattern across regions, not the level.

Another BIS paper distinguishes three types of digital platform expanding in financial services: fintech entrants, big tech firms and, increasingly, incumbent financial institutions with platform-based business models. Each brings a different mix of customers, data and funding to lending.

Four questions for any model

Before looking at any fintech lending arrangement, it helps to answer four questions in writing:

• Who faces the customer, and whose name is on the loan contract?
• Who holds the licence and makes the credit decision?
• Who funds the loan, and from what money?
• Who bears the loss if the borrower does not repay, and who answers to the regulator?

Which licences each part of the chain needs differs by market; the rules pages show what applies where.