I just came across the news that Facebook has a patent on an invention that allows lenders to view the credit scores of our circle of friends on Facebook to determine whether or not we are creditworthy. Check out some coverage here.

We at Lumenous are deeply concerned about how social data are being collected in unexpected ways to derive unexpected conclusions. Hence we had tracked this matter of “collective” credit scores for some time. Check here for coverage from almost exactly two years ago.

And here is a post from our own blog that slightly predates the 2013 reports on Facebook and credit.

Why new coverage now? Primarily it’s just that an updated patent on this bit of Facebook technology has been granted. But consider the differences in the headlines from the August 2013 report and this one.

In 2013: “Choose your Facebook friends wisely; they could help you get approved — or rejected — for a loan.” The caption indicates it could cut both ways but overall the body of the article is upbeat. The practice of using social data is going mainstream, it reports. Small businesses and consumers who are active in social networking may be able to get loans not otherwise available to them.

In 2015 a very different tone: “Facebook patents technology to help lenders discriminate against borrowers based on social connections.”

In just a few years we’ve seen regulators such as the Federal Trade Commission and academics at schools such as MIT expose the downside of practices like using your friends’ credit scores or other too-big-to-understand data. It seems to us that this passage of time has also begun to expose some hard truths about the startups using social data to profile people for credit and/or lending purposes.

I don’t think we’re done seeing new lending marketplaces and platforms emerge that emulate this behavior. More money will flow to existing companies in search of the big exit as well as to new companies. Maybe regulators will begin to rein in the worst of the practices. Just forcing some transparency as to data collected and weight given would be good.

The better option is one we are driving wherever we can and that’s to introduce new technologies that take the opposite path of secret profiling systems. There is fascinating and patentable technology to be invented that puts people in charge of their data. Or at least gives them visibility.

Otherwise, we have to hope Facebook will add a box to fill in credit scores to its friending interface!

LaVonne

Founder

Data and Society is a think/do tank in New York City, initially funded by Microsoft and supported today by prominent organizations such as The Ford Foundation, Omidyar Network and the Bill and Melinda Gates Foundation. The team and an impressive group of Fellows (mostly faculty on sabbatical from their universities) take on the thorniest challenges in our increasingly data-driven society. Here you find lively debates on the ethics of predictive analytics, whether Facebook is a media company that should manage news feeds in the public interest, and more.

Earlier this month, the team published a paper on one of our favorite topics Peer-to-Peer Lending. It’s a comprehensive overview of how this less than 10 year old industry has evolved. All of them as originally venture-backed startups launched with promises of fast lending thanks to technology and “disintermediation,” financial inclusion for many who would not otherwise qualify, and greater transparency in the lending process. All this sounded even better in the wake of the 2008 financial crisis and regulated banks tightening credit.

The reality is a bit different. Or at least it is a different landscape today. Whereas these communities once boasted individual lenders who would pick and choose from prospective borrowers (several options exist for consumers as well as small businesses), the paper explains how “the majority of peer-­‐‑to-­‐‑peer loans are purchased by large
investors like banks, hedge funds, and wealth management firms. The promise of disintermediation, or removing the
banks from the equation, has given way to a wide array of intermediaries, including but not limited to banks.”

And what about efficiency, inclusion and transparency? Speed still characterizes lending decisions but apparently at the cost of giving many more consumers and small businesses access to capital where they had no other options and it appears that transparency is mostly a promise to the lenders, i.e., the ability to compare loan payment performance.

This is our concern–whether or not peer-to-peer lending was a model that could last, those promises were really important. We do believe that technology can deliver on them but it does require a re-imagination of the system. One that is at least a little more impervious to the return of the intermediaries.

More on that later. Meanwhile, check out Data and Society and read the paper here.

LaVonne

Founder

I easily tire of Silicon Valley fads. One is the (recent) ubiquitous use of the term unicorn to describe super-unique start-ups that become huge wins for investors. Also my daughters trained me in a different view of unicorns.

Still, today’s TechCrunch post that used the term caught my eye. The author is predicting a new era of intelligent data that will support many unicorns. Read it here. The content I found most interesting is:

“In 10 years consumers and small businesses will place and control all their data in a repository with the expectation that the repository will make recommendations in the best interest of the customer, with full transparency, and the predictive/reactive nature of the data will yield the most accurate results, hence the best customer experience. The repository will hold credit + banking + transactional + social data (at least).

The incumbent unicorns will continue to bolt on small to medium-sized opportunities built on the natural data generated by their core businesses (e.g. Amazon Financing, QuickBooks Financing). Their limitation will be the lack of global data view of the customer, as well as customer trust.”

I disagree on one point. It isn’t necessary to wait 10 years for this development. If we take our eyes off fantasies such as launching a unicorn and instead focus on the immediate challenges for people (like the owners of small businesses) who feel the brunt of a broken credit system, we could well be on the brink of a great replacement to credit bureaus. And we better be. Another thing I’m sick of is the many years of articles on how the credit system is broken!

–LaVonne for Lumenous

Two stories from very different contexts came across my news feed today. The first announced a major investment in a small business lending service. The other took a fresh look at the war against drugs and the origins of addiction.

Let’s begin with the piece I read first thing this morning. I have written earlier on the phenomenon of vertically integrated, big data-driven loan services. On Deck Capital may well have been the first. Many more have followed and today they account for well over $1B in venture capital financing. What’s not to like? Small businesses need more capital right? Why not create automated lending machines to get them funds a typical bank cannot provide.

I watch these deals with interest. I understand why investors like them. Quite apart from the apparent value of increasing the flow of money to business owners, their reliance on emerging data science makes their intellectual property compelling.

But what nags at me is something our research found over and over again. The more isolated a business owner, the more risky a bet. Couple capital with connection, and the odds of payback go up. This is the essence of relationship lending. Lenders know their borrowers and thus are able to provide counsel. Borrowers who come to know and trust their lenders, gain insights and support to grow. We heard many a business owner cite their banker as their single most important partner.

Lending machines sacrifice connection in the service of efficiency.

I was pondering this when i saw the piece on drug addiction. I’d recommend reading it over relying on my summary but here’s what jumped out at me. Rat tests on addiction often involve an isolated rat in a cage. Run similar tests on rats living in a community and they still experiment with drugged water as compared to pure water but the rates of addiction drop significantly. The author concludes that human connection, love if you will, is predictive of resisting drug dependency.

Here’s an attempt to connect my strange juxtaposition. The credit industry’s variant on addiction would be a high risk business or one that just isn’t creditworthy. My challenge to lending machine start-ups is find a way to bring connection into the mix. Or, maybe the challenge should be to banks, especially those that already excel at relationship lending. Find a way to bring efficiency into your process but please do not lose the connection piece of what you deliver.

The Federal Trade Commission (FTC) has spoken. In a lengthy piece released a few weeks ago, the FTC took on the $150B data broker industry. Many of the companies focus on data collected for behavioral marketing/targeted advertising but credit bureaus comprise a significant segment of the industry.

The title is descriptive–“Data Brokers: A Call for Transparency and Accountability”

Regulators have chafed at this industry’s opaque data collection and management practices for decades. The extent to which they buy and sell data with and from each other is a major concern. In other words, data may be collected by one broker for a seemingly innocuous purpose and later finds its way to a broker using the data to adversely profile the subject.

Now as many incumbents are adopting super-powerful big data systems, the FTC and others are more urgently calling for new regulations.

We at Lumenous are pleased to see this level of attention. Anything that exposes the industry’s practices in a way that leads to greater understanding is a good thing. The FTC even provides helpful tips on how a more “compliant” system could work. People could access their data, correct it, and exert some control over how and where it may be used.

So far so good.

But then, near the very end of the report, the FTC notes that Congress would have to consider how these newly open systems would preserve data security and fidelity. Remarkable. Data brokers we know argue for opaque systems for exactly that reason. Historically the assumption has been you cannot assure anyone that the data are secure and trustworthy unless they are managed in a tightly controlled system.

The good news is that technologies already exist to allow for an open access system without sacrificing security and fidelity. However, it seems more likely this kind of great outcome will come through innovations and not regulations.

To drive home a final and important point. Today’s data technologies are more complicated than ever before. The scope, provenance, and structure of data are more complicated than ever before. When those of us in the space struggle to keep up, how is it Congress could figure out this rather delicate balance.

More regulations than we have to day could be useful. Still, I hope more innovative companies will release great technologies that resolve the matter of open yet secure and trustworthy, showing the way for regulators before to much gets “cast in stone.”

–LaVonne for Lumenous

“Creditworthiness is like virginity. It can be preserved but not restored very easily.” -Warren Buffett

We’ve written about bank criteria for lending to small businesses but there’s nothing like getting it straight from them. This is a summary of a great piece from Chris Nichols. To read the original post, click here.

1. Be clear what you need and why

Chris actually begins by noting the dearth of educational programs on how to get a loan. As he explains this first point, I thought about how much content is available on marketing and sales tactics. Getting a loan is almost the same. You’re marketing your business and selling the lending “opportunity” to the bank.

2. Underscore quality of the team

Chris spends a great deal of time on this point. In my view, it’s the single most important part of your pitch. External conditions may change. Your financial outcomes may differ from what you hoped. But when there is a strong and experienced team at the helm, the odds of surviving tough times go up exponentially.

I’d add one more point to Chris’s suggestions. Log into LinkedIn and beef up your profile and make sure everyone on the team does the same. It makes the bank’s job so much easier. Plus, it gives you a way to connect with advisers and mentors who can increase a lender’s confidence in the team. I routinely see small business owner profiles that are super lean. I assume that’s because they see LinkedIn as the place to look for jobs. Today it’s become a complete framework for proving all the points Chris makes about team.

3. Be prepared with transaction details

I’m just going to quote Chris:

Our common advice to companies is when talking to your banker, be ready to build a case why you are a good steward of capital. The business owner or management team that shows they have a well thought out plan for their business, quickly gains our trust.

4. Identify the risks!!

Make that, don’t ignore the possibility of failure. Again, Chris says it well:

This point is a little counter intuitive, but you are going to have to trust us on this one – tell us about why you might fail. As bankers, we are thinking of this anyway, so you might as well get this out on the table and lead the conversation. . . .  The more you identify the risks, the more confidence we have that you are prepared for those risks.

5. Close with timing and next steps

I know. Most business owners will assume the banker will drive the discussion of timing and next steps. But showing that you know and understand how this might play out or by introducing the subject, you show the banker you intend to be a partner in the process.

There are more nuggets in the original piece. Here is the link again in case you missed it above.

Just an additional comment on the author. Chris has become one of my most valued advisers. His insights into small business lending come out of years of experience working with thousands of community banks. Chris currently serves as Chief Strategy Officer at Centerstate Bank and also brings experience in crowdfunding for small businesses and financial services technologies.

Thanks for the insights Chris!

–LaVonne Reimer, Founder