In lending, trust is critical yet fickle.
Strip away the labyrinthine moat of legislation, regulation and contracts that guards the institutions providing this service as well as its beneficiaries, and one will find that it is trust – in its most fragile and notional form – that makes the very existence of lending possible.
As an entrepreneur running a tech service provider company, I often find myself discussing trust as our lender-partners would – do they trust a borrower enough to invest in them? How do they assess their customers’ creditworthiness? What are the yardsticks on which such trust can be measured? And so on.
In fact, this governs a lot of what we do at FinBox – generate intelligence that gives a view of borrower creditworthiness, and build infrastructure through which the contract of trust between lenders and borrowers can be carried out.
But, trust is a two-way street.
Borrowers, too, have the right to extend or withhold trust from their lenders. It tells them if they will be offered the best deal in terms of loan principal, interest rates, amortisation, and if loan lifecycle management and recovery will be handled with the utmost standards.
Unlike lenders, they might not have an armoury of tools to judge the trustworthiness of those providing this service. How, then, do they come to trust a lender and what is its significance?
To answer this question, we must first define what trust is. It is the firm belief in the reliability, truth, or ability of someone or something.
Borrower trust in lenders is engendered by state-enforced regulation, the trust of equity investors who bet on them in the market, as well as the inherent trust of depositors who trust them with the very earnings and savings leveraging which banks lend.
In other words, a lender is “trusted” if its stakeholders are convinced of a world in which the lender will never make a bad loan.
Obviously, here I speak in absolute terms. In truth, trust has an intricate relationship with other factors like market conditions and (evidence of) lender performance, or reputation. In fact, the fallibility of trust can be measured against these. If market conditions and performance do not affect the cost of funding for a lender, it speaks to its stability and high levels of trust.
What kind of lenders do you picture from this description of trust? Regulated, licensed, institutional lenders.
What happens when trust breaks?
Once trust is compromised, institutional and enforced contracts become the proverbial perfumes of Arabia that will find it almost impossible to salvage a lending institution. The 2009 economic crisis showed us what a complete breakdown of systemic trust in financial institutions looks like, and how difficult it can be to reignite it.
But financing is required even in times of financial turmoil. How, then, do consumers of credit borrow? By counting on lenders’ reputation.
Trust and reputation can be defined using the same words, but the two are more sisters than twins – trust is a belief in the reliability of something, whereas reputation is a widespread belief that something has certain characteristics.
While trust is more intrinsic, reputation is the result of manufactured perceptions. Often, these perceptions result from evidence of the lender’s prior performance, efficiency, and track record. Digital lending, and the larger discourse it has triggered around the operational competence of traditional lenders vs new ones, is shedding light on the growing importance of reputation.
The hierarchy
In times of economic downturn, can reputation take the place of trust in its absence? No, there is a hierarchy at play.
Trust always comes first. It determines the cost of financing, and acts as a defence against adverse reputation. But once it is lost, lenders are often subjected to an assault on their reputation as well. They may be viewed as self-interested, and the cost and availability of financing may then be determined by this reputation.
Essentially, trust protects reputation. And if it is lost, it is the lender’s reputation that governs important aspects of the lending business, like demand for loans, financing costs, and availability of capital.
Balancing trust and reputation
Reputation acts as a second-in-command to trust. The present rise of digital lending has placed the lending sector in a unique position – technological solutions available to lenders today can provide reinforcements for lender reputation like never before.
What I mean by this is that tech services have improved the efficiency of lending operations by leaps and bounds, machine learning-based underwriting models have facilitated speed and high levels of precision in risk assessment, and the astounding agility of digital infrastructure available today has made innovative and tailored credit products easily available to a vast portion of the credit-hungry market. All these factors contribute to a lender’s ‘reputation’ as defined above.
While licensed lenders command the ‘trust’, FinTechs have the tech that influences ‘reputation’.
The bank-FinTech partnership model acts as a defensive measure to secure the financial ecosystem against risk by allowing only trusted, licenced entities to lend. But it also inadvertently ends up fortifying lenders in the event of a breakdown of trust by allowing them to work on their efficiency and performance, or reputation. Such partnerships, therefore, are all but set up to survive financial crises and the erosion of trust.
That’s all from me this week!
Cheers,
Rajat