American’s Evolving Access to Credit

In the Philippines only about 2 in 10 persons have access to the formal banking system and a further smaller number from these few have access to banking credit, which has largely been inhibited by regulations

In the US, credit history serves as a major requirement for credit access.

From the Guardian

At 24, Josh Waldron thought he was ready to buy a house. He paid off his college debt, only two years after graduating. He saved enough for a down payment. All in all, he and his wife were ready to leave a life of renting behind.

Then his plans ground to a sudden halt. Waldron’s credit score had disappeared.

“How did this happen? It just didn’t make sense to me that I’d have a nonexistent score,” says Waldron, who is now 28. He had applied for a mortgage loan a few months earlier and found his credit score to be a robust 718.

So what happened? How could a person who was financially responsible and paying his bills on time just wake up one day with no credit score?

The culprit turned out to be his debit card. Waldron, eager to avoid debt, used his debit card to pay his bills and buy what he needed. He had never used credit cards.

The catch: no credit cards meant no credit.

And the lack of access to credit card has been growing, from the same article

Waldron is not the only millennial who has hoped to make a go of it without a credit card. According to recent FICO study, in the last seven years the number of those 18-29-years-old living without a credit card increased by 9%, going from 7% in 2005 to 16% in 2012…

Having a FICO score – that key to financial maturity – requires having at least one account that reported to a credit bureau in the past six months. Yet a lot of millennials are walking around among the 50 million people with no credit score, and thus, no access to credit.

Seen from a different angle, the US banking system rewards chronic borrowers.

Yet the dearth of access to credit has not been limited to the millennial generation, a significant number of non-millennial have also been affected.

Here is a snippet of a recent survey conducted by Federal Reserve Bank of New York on the Unmet Credit Demand of US households.

Within each bar, the three kinds of groups—accepted applicants, rejected applicants, discouraged borrowers—are denoted with a different color. Here we can see substantial differences in the composition of the groups. Compare, for example, the lower-income group (those with annual household income below $50,000), and the high-income group (those with annual household income above $100,000). Both groups demanded credit at similar rates: 61 percent of lower-income households and 65 percent of high-income households demanded credit over the past twelve months. But 33 percent of lower-income households were approved (the light blue bar in the figure), while 57 percent of high-income households were approved. Likewise, while 13 percent of the lower-income households were discouraged borrowers (the maroon bar in the figure), only 0.3 percent of the high-income households fell in this category. A similar pattern plays out when comparing unemployed and employed individuals—a larger proportion of unemployed respondents do not apply because they believe they would be rejected, and those who do apply are rejected at a higher rate than the employed.

Since the world doesn’t operate on a vacuum, under served credit markets by the formal banking system has been matched by the  informal sector.  

The emergence of informal pawnshops has partly filled such demand.

From the Wall Street Journal: (bold mine)

Borro and other collateral lenders—essentially high-end pawnshops—are a small but fast-expanding part of the shadow-lending system. Since 2008, as commercial banks have cut lending to small businesses, such alternative lenders have helped fill the void.

In some states, collateral lenders can charge interest rates exceeding 200% annually because the business isn't bound by traditional banking laws. On the upside for borrowers, there isn't a credit check and little paperwork.

So some entrepreneurs are hauling treasured possessions—Baccarat chandeliers, Picassos, Maseratis, even Houdini's handcuffs—to Borro and others to bankroll businesses historically financed by conventional loans, credit cards or not at all.

In Ms. Robinson's case, Borro was familiar with her Elizabeth Catlett sculpture: She had pledged it before to fund charitable events.

Borro is the largest of this new breed of collateral lenders, having lent nearly $100 million since opening in England in 2009.

Competitors such as iPawn Inc. and Pawngo collectively have lent tens of millions of dollars.

"If it continues being this hard for consumers and businesses to access credit, we think this can be a multibillion-dollar industry," says Paul Lee, a partner at Lightbank, a venture-capital firm that has invested $3 million in Denver-based Pawngo.

Aside from specialty pawnshops, many Americans have dropped out of the formal banking system to rely instead on payday lenders or rent-to-own services as I earlier noted, aside from online P2P lending.

The notion that there have been less demand for credit from the banking system has hardly been an accurate representation of reality.

Instead credit scores, bank regulations and lending standards, the banking system’s financial conditions, the state of the economy and many other factors including even a change in people’s mindsets and confidence levels, as well as, technological advancements have combined to influence the changing patterns of American households’ access to credit.

Japan’s post bubble bust era produced the same shift out of the banking system.

Nonetheless, the markets always finds ways and means to meet such shift in demand.

And it is not just credit, even corporate financing has been evolving. Venture capital is being complimented by – Corporate VC, Competitions, Conscious Capital, and Crowdfunding, according to Lux Research.