The lending space has changed dramatically since ole George Bailey ran the local Savings & Loan, but never so much as in the last year or so. A major “disruptive” force in this change is online lenders, aka “shadow banks,” P2P lenders, or Fintech — companies like LendingClub and Prosper. In 2014 alone, venture investment in Fintech tripled to $12.2 billion. According to Goldman Sachs’ “The Future of Finance 2015” report, while it took Prosper eight years to reach the first billion in loans issued via its platform, it took just six months to reach the second billion
Over the next 5-10 years, we’ll see this landscape continue to evolve as new entrants emerge and conduct lending activities outside the banking system, if a few large issues continue to be in their favor:
- Stricter capital requirements of banks, along with tighter regulations that are not applicable to non-banks, provide an opportunity for these entities to provide lending with less documentation and in a more automated fashion (lower cost and faster delivery)…for now.
- Banks have had to tighten credit boundaries and are limited to higher grade credit customers, basically giving more leveraged borrowers to the non-banks.
- Because the leaders of these companies are tech focused rather than finance focused, they are more largely committed to satisfying the consumer need for speed and “painless” interaction.
- They understand how to use technology and data to intersect these two demands to create a better experience than the firms holding the largest share. Their technology-friendly DNA enables them to innovate faster than traditional banks can evolve.
- Especially in borrowing money, borrowers prefer impersonal interaction, almost to the point of anonymity. They are not concerned with having a “relationship” for lending. As long as the process is easy to apply, quick to answer, and the lender actually lends the funds, borrowers actually prefer not to have personal interaction – even at a higher cost of interest.
What does this mean for the future?
- Lending revenue at risk for banks: In 2014, banks earned ~$150 billion from lending activities across consumer, small business, leveraged, mortgage, commercial real estate, and student lending. It is estimated that 7%, or $11 billion, of annual profit from lending could be at risk from these new players entering the marketplace (Goldman Sachs 2015). This outlook is creating pressure for banks to understand what borrowers want (speed/automation/approval) and quickly adapt to defend their market share, remain competitive, and grow.
- Banks are one of the largest lobbies in Washington, so don’t think that they won’t push for non-banks to be regulated in a way that is commiserate with their own plight. Some larger online lenders are already under watch by the Financial Stability Oversight Council (FSOC) and could be forced to conform to regulatory measures. Additionally, banks may begin to put pricing pressure on the non-banks, particularly if they can keep deposit rates low. Banks are not going to allow continued loss of much-needed lending revenue to persist.
- Most banks are frantically trying to upgrade technology to provide ease and quickness, and some are even partnering with non-banks to be a lending interface. However, bank tech is a bigger issue than just lending. There is a desperate need within banks to provide customers with better information/education, quicker service, and more relevant interaction to protect and grow long-term relationships, particularly among more valuable customers. Banks are making headway.
- New entrants in the lending space is not a new phenomenon; however, there is concern for how long these growth trends will last. The past has shown that new lending players have caused traditional banking to reduce pricing, acquire or build similar platforms, and push for additional regulatory scrutiny of these entrants to “level the playing field.” And, for the most part, banks have succeeded in the past. The question is how quickly they can close the gaps.
Fintech has definitely exploded as a viable borrowing option for many. However, they may be on “borrowed” time if they are eventually held to tighter regulations on par with banks and if borrowers feel that they can receive comparable pricing and experience with traditional banks (a name they know and trust). In the meantime, this niche in the financial services industry will continue to grow and thrive.