The Evolution of Payday Loans: How Technology Has Changed Microfinance Institutions

Microfinance organizations have gone a thorny path from companies that issued loans to everyone to fintechs with modern scoring systems and artificial intelligence. What’s next for the industry?

The market for microfinance institutions is actively developing in almost all corners of the world. Perhaps the rapid growth rates of this segment are related to the high demand for microfinance from the population. But in order to compete with traditional banks, MFIs have to be as efficient as possible. For this, companies are actively introducing new technologies, including algorithms for analyzing and processing data.

Now the rapid development of the Internet and the market of mobile gadgets has led to the emergence of strong players in even less developed countries.

Bad reputation – good prospects

In some countries, MFIs have a very negative image. This happened partly through the fault of the companies: at the stage of the emergence and formation of the microfinance industry, a huge number of unscrupulous and unprofessional organizations worked on the market. Interaction with borrowers was quite tough and was sometimes accompanied by outright banditry on the part of the collectors.

Clients, on the other hand, did not always clearly understand what they were doing when they sign a loan agreement, because the hidden conditions were deliberately written in small print. At the same time, the new segment was practically not regulated by law. Is it any wonder that the industry has formed a bad reputation?

So why, in spite of everything, payday loans are actively developing not only in Canada and the USA but also in less developed counties?

First, rumors of excessively high interest rates are greatly exaggerated. If we compare them with traditional bank rates, then we see that they are approximately at the same level.

Financial frivolity

Of course, the general level of financial literacy among the population is higher in Canada and the USA than in other countries, which can be explained by a number of reasons. For example, both in Canada and in the United States, the population is a tax operator. People are used to counting their money and reporting to the state on their own. In less developed countries, part of the tax deductions falls on the shoulders of employers, who deduct them from the employee’s salary even before being credited to his/her bank card.

On the one hand, this option, of course, is convenient for the employee, but at the same time, many people do not realize their role in shaping the country’s budget, as a result of which they do not closely monitor the efficiency of spending these funds by the state.

On the other hand, some people are rather frivolous about their own personal or family budget. Due to the low level of financial culture, our fellow citizens often use payday loans incorrectly, turning them into long-term and extremely unprofitable loans. Therefore, it is not surprising that a convenient financial instrument has gained negative fame in some groups of the population. However, the situation is gradually improving due to the actions of the regulator – Federal Reserve System, and there are more and more borrowers who use payday loans for their intended purpose.

Now the main obstacles to the further development of the global market are associated with the actions of the legislative bodies. So, quite recently, deputies in some countries called for the elimination of payday lenders, deciding that such a measure would reduce the crime rate in the country. In their opinion, the main problem of MFIs is that the presence of large debts pushes citizens to commit offenses in order to pay them off.

Interestingly, the opposite trend was observed in North Dakota, United States: with the spread of payday loans North Dakota, the level of offenses associated with robbery and theft decreased.

Thus, the only factor limiting the process of introducing financial technologies in some less developed countries is now the administrative barriers associated with the inertia and imperfection of the legislative system.

From usurer to fintech

Now MFIs no longer have practically anything in common with the companies that originally worked in this market. Previously, everyone could get a payday loan, a preliminary assessment of the risks of non-repayment of loans was not made at all, and conflict situations were resolved by psychological pressure or even forceful methods.

Today, microfinance companies position themselves as representatives of the fintech industry and effectively apply innovative risk management methods, introduce cybersecurity and artificial intelligence technologies for processing big data. The blockchain is of great importance – more and more services will soon be organized in the form of a continuous sequential chain of blocks built according to certain rules.

The use of online financing and planning tools, according to experts, is one of the main drivers of growth in the global economy. Such instruments are becoming more and more popular. In this respect, payday loans have become a demanded service. Today, all information about payday loans in your city can be obtained online. Thus, if you reside in Minot, ND, you can visit payday loans Minot ND to get comprehensive information about this product, in particular, you use an online APR calculator, check out a list of licensed lenders in your city and read user reviews.

According to statistical studies, in the United States and Canada, middle-aged women most often become borrowers. In Europe, payday loans are also in demand mainly among disadvantaged segments of the population, including former emigrants.

The terms and conditions of the agreement, as well as the size and terms of loans, are also determined by local prerequisites and the needs of specific borrowers. The average loan amounts in the USA and Canada are almost 10 times lower than those taken by borrowers in Europe, which can be explained by the difference in living standards, average incomes of the population, etc.

Spain and Poland turned out to be the most promising in terms of European microfinance market development. The increase in demand for these services in Spain was largely due to the deep economic crisis of 2009, which led to a record level of unemployment for the country and high mortgage debt. As a result, a huge number of MFIs began to appear. Almost 60% of financial transactions are carried out by Spaniards online, including using mobile applications.

The Polish MFI market is also considered one of the most developed in the world. It is represented by large international companies, including such giants as Twingo, Wonga and Kreditech. Many technologies for automatic risk assessment online were first tested in Poland, however, loan rates in this country are at the average European level, losing in this respect to Spain.

Regulator footrest

Despite some differences in legal regulations, the working environment for MFIs in the United States and Canada is almost identical. Moreover, the rules for borrowers in these countries are somewhat tougher than in Europe. In the West, almost any resident can get a payday loan.

No matter where you live, you will be able to become a borrower if you have reached the age of majority: in order to receive a loan in some organizations, you will only need to provide a government-issued ID. However, due to the age qualification, the involvement of young people under 25 in lending remains low. It is possible to increase the share of young people among borrowers through the development of online services, including e-commerce.

The appeal of young people to MFIs is mainly due to the availability of convenient solutions in the product lines of microfinance companies – virtual credit cards, which are actively used for purchases in online stores; various financial assistants who help plan their expenses online using convenient mobile applications, as well as bonus and savings programs.

The credit risk of young borrowers is on average considered higher than that of the older age group, but at the same time, according to some studies, their ability to create debt is underestimated by about 40%. This means they are less trusted than they should be. To overcome this barrier, special psychometric systems can help – they will perform scoring on the basis of alternative data to assess hard-to-measure qualities of borrowers, such as their success and willingness to pay.

At the same time, in the payday loans segment, which is the main one in the USA and Canada, the number of young people among clients is noticeably lower. Borrowers of older age categories are characterized by greater conservatism: they prefer offline services, although the situation is beginning to change due to the widespread use of mobile devices and the development of the Internet.

Gradually, the negative perception of MFIs as unscrupulous companies and borrowers as representatives of disadvantaged segments of the population is becoming a thing of the past. The share of borrowers who take payday loans out of despair is already less than 20%. Most likely, in the next few years, companies in the sector will completely cease to be associated with the image of modern usurers who profit from someone else’s grief, and the introduction of attractive financial products in their line will help them attract even those clients who previously used exclusively the services of classical banks.