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Diversity and equality Small business banking


COMMUNITY BANK, LOAN MARKETPLACE PILOT TRANSACTION-BASED UNDERWRITING

By  Miriam Cross
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April 21, 2023, 5:08 p.m. EDT 4 Min Read
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Complimentary access to top ideas and insights — curated by our editors.

Texas National Bank has been strategizing how to tackle social issues in the Rio
Grande Valley. 

One example is its no-fee small-dollar loan, built with bank and credit union
technology provider Velocity Solutions and meant to counter the abundance of
payday lenders operating in the bank's communities. The interest rate will hover
just under 18% and the product is expected to launch within days.



Another initiative is a pilot project with Lendio to deploy transaction-based
underwriting for small-business loans. Although Lendio is better known for its
business loan marketplace, where it sources borrowers and solicits offers from
its network of bank and nonbank lenders, it is testing alternative underwriting
capabilities with Texas National, which is based in Mercedes.



"We realized through years of experience that fintech lenders have gotten really
sophisticated at quickly analyzing borrower applications, generating decisions
and often using transaction data as a way of evaluating the borrower rather than
relying so heavily on income statements and credit scores," said Philip
Taliaferro, general manager and senior vice president of software as a service
at Lendio.




The goals are reflective of other small banks and minority depository
institutions: to learn how to lower costs, increase efficiency and improve the
customer experience using technology, in this case with small-business loans.
Taliaferro and Rey Garcia, executive vice president of Texas National, will
discuss their pilot on June 12 at American Banker's Digital Banking Conference.

"When we see the fintech world taking over the banking world, it keeps me up at
night," said Joe Quiroga, president of the $679 million-asset Texas National.
"This was our small attempt to say, we've got to innovate and keep up with it;
we might not develop the next best product but we will learn a lot," such as
which algorithms or automated processes can take over more efficiently from
human analysis.

"We don't have huge expectations for growth, but we have huge expectations for
learning," he continued.

Diversity and equality
Innovation reflects immigration at Texas National Bank

The minority depository institution largely caters to Mexicans in the U.S. Their
trust in smartphones and distrust of traditional banking has influenced its
approach to developing digital tools.

By Miriam Cross
February 2


Such experiments with alternative data may also trigger the question of how
viable alternative transaction-based underwriting is compared to traditional
credit scores.

Texas National's largely immigrant customer base frequently operate in cash, and
do not borrow often, which means creditworthiness may not be reflected in their
credit scores.

"What got us excited about this product is how we can be socially mindful and
create this responsible solution to allow small-business owners that primarily
operate in cash to get credit," said Garcia. "This tool that analyzes
alternative data lets us improve the speed and accuracy with which we make
decisions."

Lendio's technology will mine customer deposit data from the bank's core system,
run it through algorithms and classify the transactions. It will tabulate the
results in its model, detect factors such as revenue over the last 30 days, or
number of days where funds dropped below a certain threshold, and pre-qualify
customers for a loan.

Taliaferro cites two reports: one from the Bank for International Settlements in
2022 that studied two lenders that used alternative data and found they
predicted future loan performance more accurately than the traditional approach
to credit scoring, particularly in areas with high unemployment; another
co-written by New York University associate professor of finance Sabrina Howell,
which found that process automation boosts lending to Black-owned businesses.

"If I rely exclusively on traditional credit scoring and traditional
underwriting models I am more likely to exclude the type of borrower I should be
more focused on supporting," said Taliaferro.

Texas National is starting slow. Currently it is restricting the pilot to
existing customers, because the bank has a rich history of their transactions
and wants to test the solution with well-known customers of the bank before
opening it to a larger market.

"We put on tighter risk limits so we can monitor performance, measure progress,
and evaluate potential issues that come up, then iterate from that," said
Garcia. "We're trying to be mindful about how much we are lending until we're
more comfortable."

Although Texas National is its first pilot customer, Lendio is also piloting
transaction-based underwriting with a large regional bank and another community
development financial institution.

Transaction data has not reached the mainstream with underwriting among
traditional banks.

"I'm willing to argue that statistically speaking, it won't result in better
loan repayment because historical transaction data is very difficult to utilize
to extrapolate future transaction data," said Mitch Wein, head of community
banking and credit unions at Aite-Novarica. There are some businesses where
transaction data may be more predictive than other types, he believes, for
instance a business with fixed and steady contracts underpinning its revenue.

However, nontraditional data can augment credit score underwriting to
potentially give users better outcomes in certain segments of lending, said
Wein. "If you can collect that data in a usable repository, in a consistent way,
and tune the algorithms effectively, you can get that outcome, which is a win
for the banks."

Texas National is currently using credit scores in addition to transaction-based
data. The bank says it will continue to assess the underwriting evaluation
process as the product evolves.

"Over time we will see the importance of alternative data continue to increase,"
said Wein, "as there is more data being generated and because of capabilities
like artificial intelligence and more advanced machine learning, [which means
we] will be able to more deeply evaluate the quality of that data for
algorithmic purposes."

Miriam Cross
Tech Reporter, Arizent
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Diversity and equality Small business banking Small business lending Technology
Learn the new regulatory developments in the wake of recent banking failures

Hear firsthand how other banks and credit unions are navigating regulatory
developments, partnering with fintechs and investing in innovation to improve
customer experience. Join us at American Banker's DIGITAL BANKING this summer.


Learn More


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