Trendsetters within the world of fintech have lauded the benefits of non-traditional lending for nearly a decade.
How safe are non-authorised deposit-taking institutions (non-ADIs), and could these unregulated lenders be contributing to housing excess currently plaguing Melbourne and other Australian cities?
“Shadow banks” are replacing big finance for Australian real estate developers.
The Reserve Bank of Australia (RBA) was recently forced to comply with a Freedom of Information (FOI) request to release 153 pages of internal documents regarding the threat that non-bank financial institutions (NBFIs) pose to the existing financial model. The declarations within these documents could be the death warrant for the old guard and an admission that a new paradigm has taken root.
NBFIs operate outside the purview of the Australian Prudential Regulation Authority (APRA), which works in concert with the RBA to exert financial control over the Australian economy. In exchange for charging higher rates, NBFIs are open to a wider pool of lenders. Combined with the convenience of securing financing for a building project from your smartphone, it’s clear why NBFIs are becoming increasingly popular among Australian developers.
Too Many Apartments, Too Few People
There is, however, such a thing as too much of a good thing. Easier access to lending means more buildings, but more buildings must be supported by more tenants. Everywhere across Australia, half-finished apartment buildings are littering urban areas, and risky financial deals are hurting Australian entrepreneurs. These are signs that something needs to change within the ruling economic paradigm, and it’s never a wise choice to go back when it comes to money matters.
The recently-released FOI documents show that the RBA has been concerned about the effect of fintech and shadow banking on the domestic housing economy since at least 2017. It’s only recently, however, that the Australian government has shown any signs of addressing the crisis.
NBFIs Are Revolutionising Housing Finance in Australia
According to RBA analysts, “The alternative market appears to be most established in Melbourne, where there is still strong conviction among developers about the outlook, but the pullback by major banks has been relatively pronounced (particularly in inner Melbourne).”
Everywhere else in the country, from Perth to Sydney to Darwin, NBFIs are having a similar effect. Investors and developers remain convinced by the value of non-traditional lending.
In 2019, the Financial Stability Department remarked that “non-ADI lending to residential property developers is growing faster than banks’ lending.” It’s clear which finance model is one the rise and which is on the decline in Australia, but it’s still unclear how long it will take regulators to take proper action.
The RBA’s Warning
In March 2019, the RBA’s chief stability analyst, Calvin Yap, issued a warning that non-bank lenders could create systemic cracks within the global financial system as a whole. While traditional lenders view this news as a cautionary tale, many commentators contend that NBFIs offer far greater rewards than the risks they present.
According to Yap, “NBFIs are not subject to prudential supervision which can, in theory, constrain risk-taking and curb pro-cyclical lending behaviour.” It’s telling that Yap had to add “in theory” when describing the stabilising role of traditional financial regulators. The truth is that the world of finance has been inefficient and corrupt for a long time, and fintech is now threatening the power that conventional financial models hold.
Change is in the Air
- Traditionally, non-bank lenders have been unregulated under Australian law.
- New regulations, however, may force non-ADIs to provide statistical information
- These reported data may be crucial to understanding just how seriously non-bank lenders are affecting the Australian and international economies.
For better or for worse, fintech is about to come under the yoke of Australian regulation. Soon, APRA will have powers to collect statistical information from non-traditional lenders. This data will be used to assess the risks further that NBFIs pose to the housing market and other facets of the Australian economy.
The Australian government recently ratified changes to the FSCODA (Financial Sector Collection of Data Act) of 2001 to force many non-traditional entities to report the same way as conventional banks. While this measure presents further legal hurdles to NBFIs, it also shows that governmental bodies are finally being forced to take fintech seriously.
Further Powers for APRA
Additionally, APRA now has the power to rule on lending activities when it “considers that the provision of finance by one or more non-ADI lenders materially contributes to risks of instability in the Australian financial system.” Essentially, APRA now has the power to impose anti-fintech rules, but history teaches it would be wise to pursue a different course.
According to the documents released per the FOI request, APRA and the RBA remain in disagreement regarding which types of entities will need to be regulated. It’s unclear which kinds of NBFIs will face further regulation, and in the end, the overwhelming evidence supporting the benefits of fintech may win the day.
What Does the Research Say?
Research into the implications of fintech on building is limited, but a 2018 article in the Journal of Financial Economics details the effect that shadow banks are having on residential mortgages. Not everything the authors concluded about fintech in housing is negative; one of the first conclusions reached in the article is that, compared to other shadow banks, “fintech lenders serve more creditworthy borrowers and are more active in the refinancing market.”
At the same time, this study doesn’t have anything nice to say about the ethics of fintech mortgages: “Fintech lenders charge a premium of 14–16 basis points and appear to provide convenience rather than cost savings to borrowers.” It’s not that fintech finance is cheaper, but that you can do it from your smartphone and sometimes limited credit reporting.
Instead of offering savings to customers, fintech appears to be basing its “interest rates relative to other lenders,” which shows how much the “digital banking boom” is still predicated on existing financial models. What will happen, we wonder, when conventional banking truly bites the dust, leaving fintech reigning alone and supreme?
Fintech Makes Its Way Into the Mainstream
“Shadow banking” refers to the wide body of unregulated financial transactions at work in the world today. On the other hand, “fintech” is commonly used to refer to technology-driven financing employed mainly for small loans. Fintech can also refer, however, to the wider financial technology revolution that is silently changing the world.
According to the Cambridge Center for Alternative Finance (CCAF), fintech lenders offered over $700 million to Australians in 2016. Keep in mind, however, how incredibly difficult it is to get any credible statistical information about NCBIs, shadow banking, or fintech in general.
Digital Finance for the People
In finance as in any industry, demand drives supply, and it’s clear that fintech is already making finance products more people-friendly. According to Calvin Yap, “there is already some evidence that a few banks are lowering their lending standards in order to remain competitive.” It’s understandable why terms like “lowering lending standards” would worry anyone who went through the 2008 financial crisis, but let’s take a look at the facts.
Fintech decentralises finance and places it in the hands of the people. Yes, fintech forces traditional banks to lower their lending standards, but only because NBFIs are using advanced AI algorithms and other cutting-edge data science technology to deliver superior products.
That’s a very different situation than a few big Wall Street banks giving loans to millions of people who shouldn’t have qualified for them to make a quick buck. Fintech is the polar opposite of exploitative; if this technology disrupts the global finance industry, it will disrupt it for the better.
Shadow Banks Step Into the Light
National Australia Bank (NAB) recently added a fintech service called QuickBiz to its lineup, and this legacy financial institution is late to the game. Conventional banks all over the world are being forced to embrace fintech or be left behind, which is leading to the inevitable legitimisation of the “shadow banks” that they have so reviled.
Rather than fighting a loosing battle against fintech; banks are deciding to get on the bandwagon in the hopes that they can direct the future of the industry from within. Such strategies are common in both business and politics, but appeasement always leads to defeat. Traditional finance has already thrown in the towel, and now it’s just a matter of replacing the old guard.
Government Admits Fintech Has Benefits
While Mr Yap’s analysis of fintech’s impact on Australia’s economy was largely sceptical, he did have the following favourable words to say:
“This could lead to more efficient credit allocation by facilitating credit provision to previously underserviced market segments, reducing the time taken for borrowers to access money and lowering the cost of finance for some borrowers.”
That’s a bunch of lingoes that essentially admits that fintech is superior in determining creditworthiness than traditional finance. By “underserviced market segments,” Yap means average people who banks have unreasonably denied finance because their systems weren’t efficient or high-tech enough to process their requests.
Yap also admits that fintech helps people get money faster and at lower rates. What more could a developer, investor, or business owner possibly want? Fintech is clearly the superior model for the global finance industry, and there’s only so long that ghosts of the past can stand in the way of true progress.
Is Fintech More Dangerous?
- Some evidence suggests that NBFIs target sub-prime borrowers who wouldn’t qualify for conventional bank loans
- However, fintech uses the latest technological tools to deliver a superior product
- Genuine oversight in fintech would be welcome, but traditional banks feel threatened
- Fintech responds to trends in real-time and uses data-rich metrics of investor confidence to set rates and other terms
- Fintech is neither safer nor more dangerous than other forms of lending; it simply needs to be used correctly
In closing, Yap had the following to say about the impact of fintech on conventional finance:
“Fintech credit currently poses limited risks to financial stability due to its small size. However, it has been growing very rapidly and is likely to continue doing so; especially if banks continue to be ready suppliers of funding.”
Regardless of what the traditional banking institution might prefer, fintech isn’t going away. Now is the time to incorporate this new class of technologies into our global financial system. If we aren’t proactive enough, Australia and the rest of the West could quickly be left behind.