Silicon Valley could be ruining fintech

Remember that friend from college who never quite matured out of the “party every weekend” mentality? Who defaulted on every student loan? Who thinks a good job is measured by how well it accommodates hangovers? Facebook does. And it might ruin your chance to get your next loan.

Facebook recently updated a patent it has held since 2010. It’s primarily used to prevent users from spamming each other. But when updating with the United States Patent and Trademark Office, Facebook described a new use that could allow lenders to analyze the credit score of a loan applicant’s Facebook friends. The more creditworthy your friends are, the more likely you are to get a loan.

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Such a plan isn’t without reason, but this particular idea bodes poorly for Facebook — another example of Silicon Valley’s failed approach to entering regulated industries.

Traditional Underwriting Needs Disruption

Fifty-six percent of Americans have a subprime credit score. Another 45 million Americans have no score at all, either because their debt history is too slim or because they have no history with debt (the so-called “credit invisibles”).

Given these numbers, it’s important that we rethink how underwriting is done. That’s the purpose of fintech firms — underwriting consumers based on nontraditional data sets and building products that allow people with subprime credit to borrow money and build their credit scores.

Unlike credit scores, which are based solely on past history with credit, the new approach uses data such as bank account information, public records, and social data to predict future repayment ability. This is helpful for credit invisibles and many subprime consumers. Leaning more on software and big data to determine creditworthiness will also improve lending applications and decision-making.

However, that’s a long way from saying that a Facebook-determined social credit score is a good thing.

Facebook’s Idea Is Unlikeable

Facebook’s patent embodies a trend in using behavioral and social data in lending decisions. This is new territory for the industry, and which of these efforts regulators will accept and which ones go too far is still an open question.

Facebook has a massive price-to-earnings ratio to live up to, and it’s doing everything it can to monetize its greatest asset: its data. This relentless monetization drive will lead to ideas whose risks aren’t always worth the returns.

Facebook’s social data algorithms will likely help lenders make better decisions, but they won’t move the needle enough to justify the regulatory risk. Given the amount of regulation in the financial services industry, this disruption could ultimately kill progress altogether.

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This regulatory layer is what makes the financial services industry unfamiliar territory for Facebook and Silicon Valley. Given past experience with regulated industries, it’s not territory where Silicon Valley companies excel.

Silicon Valley Is Ill-Suited to Financial Services

Silicon Valley has a great track record with unregulated markets like the Internet and software, but its firms haven’t done well when trying to disrupt highly regulated industries.

Remember when Silicon Valley was going to be the savior of our energy dilemma by innovating clean energy technology? Remember the black eyes that followed for investors and regulators when clean tech companies went bankrupt? Those failures cost taxpayers dearly.

Fintech disruption can only move as fast as regulators are comfortable. Yet the Valley tends to treat everything like the unregulated software or Internet industries. That is not the road to success.

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Successful Disruption Embraces Regulation

The financial services industry will be disrupted. Traditional lending fails too many people to continue in its current form.

But to be sustainable in the long term, fintech disruptors must:

• Respect industry regulations and work proactively with regulators to ensure that disruption benefits both the company and the consumers.

• Be strategic about challenging the status quo, as regulators will only adapt as fast as the market does — if fintech innovation outpaces the market’s willingness to accept it, regulators will react negatively.

• Be economically viable independent of government regulation or subsidies — just as regulation must be respected, so must the free market.

Watch for fintech innovators that follow this path. They will find success.

Dusty Wunderlich is the founder and CEO of Bristlecone Holdings, a high-growth network of consumer and business-to-business finance platforms and financial technologies. Dusty is a current recipient of the Twenty under 40 Awards in Reno, Nevada, and is a member of the Young Entrepreneur Council.

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