Nik Milanovic
Contributor
Nik Milanovic is a fintech and financial inclusion enthusiast, with a decade of work across mobile payments, online lending, credit and microfinance. The opinions expressed in his articles do not reflect those of his employer(s).
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As the U.S. flirts with extreme market volatility and the possibility of its first recession since the 2008 financial crisis, it’s amazing to think how much consumer financial services have changed in that time. For the last ten years, fintechs have relentlessly democratized financial products by lowering the barriers to use them.
But democratization brings its own risks. To truly improve the lives of their users and guarantee long-term customer loyalty, fintechs should add guardrails and adopt their own version of medicine’s Hippocratic Oath.
Financial institutions and fintechs of the last decade brought unbanked and underbanked consumers onto the ‘financial grid’ in a way that empowered many for the first time. Now, there is a big opportunity to give consumers not only access, but also guidance for how to use financial products in a responsible way. While the first phase in fintech innovation was defined by users’ financial access, this second phase will be defined by their financial health.
During that first phase over the last ten years, financial services became ‘democratized’ at a breathless pace. If someone wanted to open a bank account in 2009, they had to do so in-person. The same was true of taking out a loan. High brokerage fees prevented them from being an active stock trader. Debit cards were used when credit card rewards were lackluster, and many paychecks were still physical.
The paradigm for all these services has shifted. Prices are lower (or eliminated), products are digitized, and an unprecedented number of consumers — not just in the US but globally — can access financial services previously unavailable to them. From personal finance startups to legacy payments companies, many fintechs now champion the cause of democratizing people’s access to finance.
It has become such a cause célèbre that “democratizing finance” could almost be considered its own fintech category, whose hallmarks include:
- Lowering barriers, such as cost, qualifications, and availability to use financial products.
- Example: Remitly lowers cross-border remittance costs; Square Capital opens term loans to asset-light businesses.
- Targeting new audiences previously unfamiliar with (or shut out from) these products.
- Example: Step provides no-fee banking and money management services to teenagers; Petal (disclosure, a former employer) gives credit access to people without credit scores.
- Standardizing products across customer demographics.
- Example: Republic gives retail investors access to the same startups as family offices and accredited investors.
But is unrestricted access always good? What are the implications of entirely removing the barriers to finance? To a higher degree than products in say education, fintech can cause serious consequences, whose effects are most pronounced on unsophisticated consumers.
As at-the-time Harvard Law Professor Elizabeth Warren wrote in 2007, “it is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance an existing home with a mortgage that has the same one-in-five chance of putting the family out on the street.” Credit cards, investing, and trading all carry similar risks.
Today’s market volatility is bringing to light the level of familiarity most people have with financial products: “I had no idea what was going on, I thought the stock market crashed and the Robinhood app couldn’t handle it. I just didn’t know,” one Robinhood user told Fortune during the free stock app’s platform downtime. Consumers have increasingly turned to forums like Reddit to demystify personal finance.
This is actually a feature, not a bug, of traditional finance. Some institutions have worked to make financial concepts non-transparent, to obscure the true cost of finance and justify hidden fees. For instance, APR, which for credit cards is calculated monthly against the average daily balance of the cardholder for the prior statement cycle, could be a simple percentage calculated against a set dollar amount of monthly spending, expressed in cash terms as well as rate.
Fintech startups have done an amazing job making products available, but democratizing access is only half the battle: the next opportunity is to improve consumers’ lives by making these products responsible.
Like democratic voting itself, financial systems will work best when people are:
- Informed. As a civil society, we can do a better job teaching personal finance in schools; it was not until taking a 1-unit elective course as a senior in college that I learned how a mortgage worked. Fintechs can help fill this gap by making information on product risks available and easy to digest for new users. Simplicity is key: concepts such as APR are inherently unintuitive and need to be explained in plain English. And this means finding a way to offset the loss to a traditional profit-center of consumer finance: using complexity to obscure the true cost of finance to customers.
- Responsible. Fintech products can introduce nudges and features that help people self-police. Clear heuristics like risk disclaimers on investments, overdraft alerts, displaying total loan obligations in cash alongside savings can give people contextual information to determine whether products are right for them.
- Limited from doing too much self-harm. This is why the ‘ability to repay’ test in lending, limits on margin in stock trading, and accredited investor requirements exist. People are notoriously bad at forecasting risk and evaluating the potential downside impact of financial products. There is a point at which limits to access become necessary to prevent overexposure to financial danger.
- Context-driven in their decision-making. Personal situations, such as backgrounds, goals, and current obligations, can vary massively from person to person. This is true even for customers who look the same on paper. Though the abundance of digital data gives fintechs increasingly clearer profiles of their users, understanding the nuance of personal context is critical to delivering healthy financial solutions.
- Incentive-aligned with financial services providers. This is the hardest question to answer: how does a company change its revenue model to dovetail with consumer financial health? This means no surprise overdraft fees without low balance alerts. No rewards programs that encourage risky spending. Moving from penalty-based revenue streams to subscription ones. Service providers should only win when consumers win.
Democratization can be dangerous without these types of guardrails in-place. To truly improve people’s financial lives, fintech should adhere to the standard of ‘first, do no harm.’
Give people risk-free environments to learn, like the dad who walked his 14-year old son through investing in Tesla stock or Credit Karma’s debt repayment calculator and credit score simulator. Leverage data to understand people’s personal circumstances. Clearly explain the outcomes — both positive and negative — that products can have on people’s lives.
Traditionally, regulators have played the role of financial health cop, ensuring that service providers remained aligned with their customers’ interests. This is why early-stage fintechs, with lower overhead, the ability to nimbly tweak products for user behavior, and their new revenue models, stand to create such significant change: they can align their incentives with customers without having to reverse course on decades-long practices.
Fintechs have a phenomenal opportunity to cement their leadership position as the go-to providers of financial services. By focusing on the long-term health of users, improving their financial literacy, and using guardrails to encourage responsibility, they can democratize access in a way that truly changes people’s lives for the better.
These opinions are the author’s personal views and do not reflect any views of his employer or other parties.
