Fintech lending by neobanks – online services with no bricks-and-mortar branches – in hitherto ‘unbanked’ markets has seen massive adoption in the past year. Digital lending start-ups raised a record $20.5bn across 633 deals in 2021, representing a 220% funding increase year on year, according to CB Insights.

Millions of individuals across the world are excluded from mainstream financial services, either due to a lack of credit history in developed markets or a lack of financial infrastructure in less-developed markets. Fintech lending is expected to reach a global value of $27.1bn by 2028, growing at an annual rate of 18.13%, according to Verified Market Research. The proliferation of start-ups in the space demonstrates that this banking segment is on the rise.

Some examples of recent funding include California-based immigrant lending start-up Stilt’s $114m raise in March 2022 and Los Angeles-based Welcome Tech’s $30m raise in April 2022. In 2021, Houston-based bilingual immigrant start-up Fair raised $40m and San Francisco-based TomoCredit raised $17m to develop a no-fee credit card focused on building credit history.

Specific community-focused start-ups include Kansas-based First Boulevard, which raised $5m in 2021 and is focused on black and Latino communities, and California-based Cheese, which raised $3m for its Asian-American community-focused platform in the same year.

While many of these neobanks are US based, London’s reputation as a fintech capital has seen companies including Revolut and Pillar establish the city as a digital lending hub. In April 2022, Pillar raised £13m in pre-seed funding for its platform that gives immigrants access to credit when moving to a new country.

The trend for digital lending has vast adoption potential in ‘underbanked’ regions such as Africa, where only 43% of the population has a traditional bank account. This trend seems set to go global, although China has outlawed its adoption.

In 2018, Beijing cracked down by suspending the issuance of licences for new lenders, according to GlobalData’s 2022 digital lending thematic research. Chinese fintech Ant Group, a dominant force in the country’s consumer lending, had its digital lending offering vetoed in 2021 as authorities emphasised the need to regulate financial technology.

Digital lending solves the inequality of credit rating scores

Although most other global markets will not adopt China’s draconian approach, the issue of fair and transparent lending decision-making has become the focus of regulators worldwide. The Biden administration has proposed a new federally backed credit bureau, mandated to ensure credit scoring is not discriminatory and includes alternative data, according to GlobalData thematic research.

The technology that underpins digital lending directly addresses this problem through transparent and uniform algorithmic decision-making, but perhaps more importantly, it provides options for the lack of credit rating for the world’s unbanked population. With advances in data science comes the ability for neobanks to calculate lending risk outside the confines of existing credit rating standards.

Los Angeles-based digital lending platform B9 began life as a service for underbanked US immigrants with no credit rating. However, CEO and founder Sergio Terentev says, once launched, the company discovered a broader market potential for its financial product among those with poor credit ratings, and a business pivot made sense. “Currently 80% of our customers are just regular hard-working Americans across all 50 states,” he says.

B9 focuses on the US market for now and on a particular segment of digital lending called ‘earned wage access’ (EWA), which provides individuals with access to an accrued but not yet paid salary – a disruptor to the payday lending companies that have traditionally exploited the poorest in society with exorbitant interest rates, according to Terentev. This anchor feature on B9’s neobank app is interest free in comparison. In addition, the company has a number of bundled products that it offers within an optional fee-based subscription model.

Most of B9’s competitors were founded in the past two to five years, according to Terentev, who has witnessed first-hand digital lending’s increased adoption. Since its inception in August 2021, B9 has reached 140,000 registered customers with about 20% of those fee-paying. The rapid growth of the company demonstrates a strong market potential and reflects the general consensus that digital lending is a growth area that is set to develop exponentially.

The market demand from this particular demographic was always there, says Terentev, but the technology was not. “Digital lending as a sector is purely technology driven,” he adds. On an ideological level, Terentev believes providing access to cheap capital to a potential market of 100 million Americans who are living payday to payday is the more socially responsible approach that will allow many to escape the debt cycle. Regulators across the US are welcoming EWA, says Terentev. “Regulators see this as a good thing in terms of consumer rights and even though it is a novel area they seem open and helpful to allowing the sector to develop,” he adds.

However, the issue of privacy and data rights still has to be resolved, says Terentev. According to GlobalData thematic research, some digital lenders have violated implied privacy laws by harvesting data from phones, with reports of even pressuring debtors by calling friends and family members to embarrass them.

Regulatory clarity is key

The breadth of services and options for the previously ‘unbanked’ is welcomed by many, but the regulatory vacuum of specific laws on digital lending is an area that many agree needs to be addressed. Regulatory clarity is key to the continued growth of this emerging financial services trend, says Stephen Walker, lead analyst for thematic and fintech research at GlobalData.

In 2020, South Korea became the first country in the world to establish laws dedicated solely to digital lending, providing credibility and validation to digital lenders. Although regulatory clarity will facilitate the sector’s growth, it has shown in South Korea that only the strongest digital lenders survive regulatory scrutiny, weeding out those unable to meet the new standards, says Walker.

In the absence of regulation, many digital lenders are applying for banking licences. For example, UK-based digital lender Zopa secured a banking licence in June 2020, and US-based digital lender SoFi applied for one in July of the same year. “Banking licences lower origination and funding costs and can also allow the technology underpinning digital lending to be applied to an institution’s more mainstream offerings,” says Walker.

Some lenders have even bought banks in order to provide credibility to their digital lending services. In January 2020, San Francisco-based LendingClub received approval for its acquisition of Radius Bank, making it the first fintech lender to buy a digital bank. By buying Radius Bank, LendingClub expanded its products and services.
As with all emerging market segments, regulation and adoption protocols are still in progress, but this emerging global trend for digital lending platforms is already disrupting traditional financial services with its central mission of democratising money for the financially disenfranchised.