Shunned borrowers have new friend in web banks

People marginalized by major financial institutions because of their low credit rating - such as housewives and university students who don’t have regular incomes and a record of financial transactions - will soon have an easier and cheaper route to loans.

Next year, they are likely to become the backbone of web-based banks, a new type of bank that will operate online without a physical brick-and-mortar branch. And a new credit assessment system being used by the online banks will allow them to enjoy loans at lower borrowing rates.

The emergence of Kakao Bank and K-Bank - the first two Internet banks in Korea - is expected to shake up the existing financial market by using big data analysis to assess loan viability.

After they won preliminary approval from the financial authority last week, the two web banks announced they will enter the loan market with interest rates of around 10 percent, targeting current holders of low credit. But they have yet to come up with a new credit rating system to eliminate high-risk borrowers and approve customers who are financially capable of repaying their debt.

The approval process involves Kakao, the nation’s largest smartphone messenger operator, and KT, the second-largest mobile carrier, tapping into the accumulated information of their customers as well as 10 to 20 consortium partners, to examine lifestyle patterns that identify financially healthy individuals.

The leaders of the Internet banks, Kakao and KT, believe their 10 percent loans are going to help those who are stuck between 3 percent loans by first-tier commercial banks and 30 percent loans offered by second-tier financial institutions.

Many welcome the debut of the web banks and their ideas about affordable loans. But questions remain regarding the reliability of the new credit rating and its impact on the financial market.

Renewed credit rating

A 28-year-old entrant at a foreign company based in Seoul, surnamed Kim, recently borrowed 10 million won ($8,600) at a 9 percent interest rate from 8 Percent, a peer-to-peer (P2P) lending startup, in a bid to repay a 20 percent student loan issued by a savings bank. Kim chose 8 Percent because he couldn’t borrow from commercial banks due to his credit level of six.

Commercial banks do not lend money to consumers with credit levels at or below five. There are three major credit rating companies in the country. Banks buy credit information that is divided into 10 levels from the companies.

But 8 Percent, which widely introduced the concept of P2P lending in Korea, lent the money Kim needed at a lower rate based on its own credit rating system. Kim got a B+ rating among 12 levels from A to D, which were developed by the start-up. The reason for the fourth-highest level is that Kim had debt other than the student loan and no history of delinquency on a credit card. The lender also looked at Kim’s social networking service (SNS) account in order to double-check his identification and credibility.

8 Percent’s approach gives a glimpse into how Kakao Bank and K-Bank plan their lending business. Kakao Bank is planning to develop Kakao Scoring, its own credit rating system.

“Kakao and its consortium partners will build a differentiated credit assessment system by using our data,” Yoon Ho-young, vice president of Kakao, said. “In order to offer reasonable interest rates for consumers with mid and low credit levels, we will add data possessed by major partners to the current credit information used by financial institutions.”

One of the major stakeholders in Kakao Bank is KB Kookmin Bank, the largest commercial bank by branch number in the country. Based on Kookmin Bank’s credit information of eight million customers, it will share user data from the consortium members - Net Marble, Loen Entertainment, eBay Korea (Gmarket and Auction), Yes24 and Tencent - to create a larger and more sophisticated database.

The additional information Kakao Bank will use with permission includes customers’ payment history at the stakeholders’ sites and all activities on KakaoTalk and KakaoStory.

“What costs the most is to attract customers, but Kakao already has more than a million users,” Yoon said. “KakaoPay has reached 1.2 million users within one month of its launch, and Bank Wallet attracted 500,000 people in just three weeks. We are the best in the mobile world.”

“By using big data analysis, we can improve the accuracy of credibility, and this enables us to issue mortgages, too,” said Lee Yong-woo, senior executive director of Korea Investment Holdings, the largest shareholder in Kakao Bank.

Kakao is in talks with Seoul Guarantee Insurance, one of the 10 consortium members, to get into the mortgage business. KT also plans to capitalize on the customer data of its 20 partners. The KT consortium has highlighted that it has a vast range of big data for about 200 million customers, including information on 26 million credit card payments offered by BC Card, and the history of mobile phone bills by KT from 30 million people.

“With the existing credit rating system, it is difficult to evaluate the credibility of customers who don’t have many financial transactions or lack personal data,” Kim In-hoe, senior vice president of KT, said.

For example, housewives and college students usually don’t have a credit level, since they are not actively engaged in financial transactions. KT estimates that the number of people without a credit level under the current system is about 10 million.

“We will help those people who used to get loans from second-tier financial institutions at high rates by establishing a more detailed evaluation model [known as CSS] by using the big data of our stakeholders,” Kim said.

“We can use delinquency information on mobile phone bill payments as an important factor to judge customers’ financial ability because paying the phone bill is the most ordinary part of life,” a KT spokesman said.

Before they can share customer information, however, each partner has to clear a legal hurdle. Currently, sharing customer information is allowed in certain cases only between a parent company and its subsidiary. The law was enhanced when information on about 100 million bank accounts from three credit card companies was leaked in early 2014.

“We don’t mean that we can recklessly use another company’s customer information, which is illegal,” a Kakao spokesman said. “We will ask for the agreement of our customers who want to get loans when examining other additional information that helps us judge their credibility.”

Improves accuracy?

As P2P lending is rising as a popular fintech business across the world, and big data has become a buzzword across industries, the combination of the two is no longer unusual.

There are active discussions around the world on measures to establish credit information systems in an innovative way to improve accuracy in predicting credibility and the financial ability of consumers, according to credit information experts.

The discussions are heated, particularly in China and the United States, where the number of fintech start-ups is growing at an explosive pace.

“A famous phrase among those fintech start-ups is ‘garbage in, garbage out,’” Moon Young-bae, head of the CB Research Institute of NICE Credit Information Service, said. “Using information collected from SNS accounts cannot help establish a reliable body of credit information. You can intentionally post positive things about yourself on SNS. We say information can have makeup on SNS.”

According to Moon, “negative information” about a person’s financial transactions is the most critical type of data when evaluating a person’s credibility in terms of finance. Negative information refers to records of delinquency on credit cards or defaults on loans.

“It is impossible to invent an accurate credit evaluation system using SNS information,” Moon said. “But if they add such information to existing credit information that has already been accumulated for a long time, it could help to improve accuracy.”

Big data analysis would help divide existing credit levels into more classes, some critics say.

“Among those who have a credit level of six under the current system, the delinquency or default ratios differ from person to person,” Seo Byung-ho, research fellow at the Korea Institute of Finance, said.

“In the same level, there are some who faithfully pay utility bills or phone bills, and some are less financially stable. It is unfair to apply the same high interest rate.

“If the Internet banks create a more detailed credit assessment system, about 10 million people who don’t have credit levels and those who have levels below five will benefit a lot,” Seo said. “That could breathe life into the financial market, too.”

10% loans

The Financial Services Commission (FSC), the nation’s top financial regulator, also expects the lending market to grow as it embraces low credit level holders.

“There will be high demand for 10 percent loans among consumers who are not qualified by major banks but cannot afford 20 to 30 percent loans by savings banks,” an FSC official said.

According to the NICE Information Service, one of the three largest credit evaluators in the country, there are 16.76 million Koreans with credit levels of five or lower as of September, accounting for 38 percent of total financial consumers (43.93 million).

The four largest commercial banks - Shinhan Bank, KEB Hana Bank, KB Kookmin Bank and Woori Bank - publicly say they offer 5 to 12 percent interest rates for those with levels of five or lower. But in many cases, commercial banks simply decline loans. These banks allow loans at rates 5 percent or lower for people with credit levels of four or higher.

Unlike the government’s positive perspective, some are skeptical of the growth of mid-rate loans. Considering high delinquency ratios of 12 to 37 percent of people with credit level nine and 10, the new Internet banks are also unlikely to approve loans for them. There are about 18.8 million.

The government has classified them as being subject to state-run microfinance programs. Excluding this group, there are 14.88 million in between levels five and eight.

“Success of the web banks will be determined by the creation of an accurate and sophisticated credit rating system that can discover healthy customers,” an official at the Industrial Bank of Korea said.

“Their efforts will stimulate brick-and-mortar banks’ innovation capabilities, making us change ourselves. But I doubt that the web banks will be able to lead the entire banking industry.”

An executive at the Korea Credit Bureau, another credit rating company, said, “In the U.S., the home of Internet banks, they are applying information on SNS to assess credit only in certain cases.

“It is important to gather trusted information, such as phone and power bills, to prevent delinquency or defaults.”

BY SONG SU-HYUN [song.suhyun@joongang.co.kr]