ZestFinance (formerly ZestCash) is no secret in the technology world — it has raised $92 million in venture capital since its inception in 2010 and co-founder Douglas Merrill cleverly uses his high-profile past at Google to explain the company’s go-big-or-go-home vision — but it may have just found its real calling. By becoming an underwriter for some of the world’s largest banks and credit card companies, ZestFinance might actually be able to achieve its goal of using big data techniques to supply the underbanked with needed credit. And, as Merrill explained to me during a Thursday-afternoon call, we’re not talking about payday loans.
On Thursday, the New York Times reported on the company’s pivot in business model; I followed up with a post about whether it will be able to keep its claim of moral superiority now that it’s essentially selling its methods to third parties that might not have been inspired by the same noble vision to get into the lending business. What neither post detailed was how ZestFinance’s new business might actually work to help reduce the approximately $8 billion extra (Merrill’s number, which seems to take into account total revenue rather than just rollover fees) Americans paid to payday lenders last year.
ZestFinance is no altruist– it’s a business designed to turn a profit, after all — but Merrill appears to believe steadfastly it’s on the right side of the ethical line. If it can take even 10 percent off the cost of payday loans, he said, that’s an annual savings of up to $800 million for borrowers, which is hardly chump change. “We’re not shooting for infield singles,” Merrill said, “we’re shooting for homeruns.”
Big banks are the key
Outsourcing its lending model to online companies such as Spotloan is one way to spread its data-driven underwriting model, but ZestFinance’s real democratizing effect might come from its pending partnerships with large banks and credit card companies. “The market won’t really be transformed until the big providers come back into it,” Merrill said, and ZestFinance provides a means for them to do that.
What’s interesting, Merrill explained, is that payday lenders require borrowers to have a checking account, which means they’re already tied into the larger banking system. Traditional banks have payday borrowers as potential loan customers, but banks often deal in larger loans (versus the $1,000 cap from Spotloan), and their reliance on traditional credit scores to assess risk means they generally won’t borrow to individuals with poor credit. What banks need is a way — like ZestFinance — to assess good credit risks who just happen to have bad credit, so they can create new products to serve them.
For credit card companies, which already have products aimed at individuals with lower credit scores, Merrill said the challenge is finding a way to increase their approval rates without taking on undue risk. There, he said, he expects a situation like what happened when ZestFinance co-founder Shawn Budde was at Capital One and the company came into the subprime credit-card market with lower APRs, forcing the rest of the industry to follow suit. Credit cards might never be the cheapest means of credit, Merrill acknowledged, but done right they can be a lot cheaper than payday loans.
And actually, he said, payday lenders have approached ZestFinance about partnerships, too, “but those are the types of discussions we’re more careful with.” Most aren’t evil, he said, they really do want to provide a service, but their inability to assess risk beyond just looking at someone’s paycheck and work history has resulted in necessarily higher rates. If payday lenders want to stay relevant, though — especially as more banks get into the business of servicing small loans — Merrill thinks they’ll have to come around to ZestFinance’s way of thinking.