Alternative lending and Peer to Peer platforms are here to stay. The question then for banks is pertinent: Should we compete or collaborate?
The P2P lending market is estimated to exceed $70 billion in the next five years, quite a sizeable number considering it was less than $5 billion in 2013 in the US. While there has been significant retail lending driven through multiple alternative lending platforms – including consumer loans by players such as Prosper, Avant and Lending Club, and also student loans by players such as Common Bond and SoFi, the key segment of significance has been the small and medium business industry. Prominent players in the SME segment being Funding Circle, Kabbage and OnDeck among others.
A conservative perspective to Peer-to-peer (P2P) lending is that of disintermediation: while banks take deposits from customers and lend to borrowers, P2P lending, also known as marketplace lending, is all about making borrowers and lenders connect directly, leveraging their technology. A more practical view could also be that of this model serving a segment that was otherwise unaddressed, where P2P platforms help investors to purchase notes or securities backed by notes with borrowers.
The cost of compliance and import of regulations for the banks have also been a boon for alternative lenders. Consider this: the top 10 US retail home lenders in 2013 had just two non-banks in them, contributing 15% of that value. Five non-banks were on that list in 2016, contributing to 40% of the value.
New age, new way of lending In essence, the core proposition is based on four fundamental differentiators:
- Financial: Superior Risk Management: Proprietary algorithms based credit scoring – using behavioural, transactional and demographic data to supplement traditional credit risk scores.
- Customer : Cost effective acquisition: Driven through engagement across social media, online portals and tools, and providing a superior customer experience
- Process : Simplified application: Quick 10-minute application with 8-10 questions and decision within minutes. Real Time updates & status indicators.
- Technology : Data, AI & Analytics: True application of digital to drive fin-tech innovation
Just as UBER is now mainstream and not a substitute for transportation, the alternative lending models have come of age too, and are here to stay. The key question then is: Should banks compete or collaborate, or would there be another alternative approach to co-exist with these lenders? Let’s explore a few strategies that are evolving globally.
- Collaborate: When ING, Santander and Scotiabank have adopted the use of the data infrastructure offered by Kabbage, it’s a statement in itself on collaborative models. This approach may not just be processing credit data and building risk models, but also potentially in customer acquisition. Partnering with P2P platforms also helps banks to identify new approaches to reaching out to customer segments not previously targeted. This also allows for banks to broaden their portfolio offering. A bank-vendor collaborative relationship can also result in leveraging and securitizing loans and custodial services.
- Co-exist: The single biggest limiting factor for alternative lending firms is their access to capital, and an innovative white labelled model could allow for P2P platforms to handle loan applications, execute underwriting process and drive services on behalf of banks, while it provides P2P players with access to capital. Interestingly, banks also find the approach of buying “blocks of P2P loans” to develop their portfolio interesting, especially in areas that are not focused by the bank – both assets and geographies, due to cost structure limitations, and also to diversify the balance sheet. This model has also assumed significance in markets such as India, where players find the basis of lending part of the loan on the balance sheet of a partner-bank to be useful.
- Compete: Banks are also now looking to develop their digital lending platforms or build a P2P lending marketplace, which serves both to address a new segment of customers and a new channel offering. An interesting example case in point here could be the Rabo & Co platform promoted by Rabobank. This hosts players such as Cloud Lending solutions, and allows the bank to address its customer needs through a ‘hybrid lending’ model. This model allows for crowdfunding as an alternative sourcing to its portfolio of SME lending, leasing, guarantees, etc. Acquisition of alternative lending platforms is not an unviable option either, considering that banks gain IP and instant market share, while it allows for logical exits for the VC/PE firms as well.
Age alone is no guarantee
While there are an estimated 6,500 banks globally, some of them in existence over 100 years, the alternative lending industry already boasts of 1,300 players powered by VC/PE funds, although they constitute less than 1% of the lending market. It doesn’t take rocket science to predict consolidation and buyouts as an obvious implication for alternative lending players. In an inevitable context of banks looking to participate in this market – either directly or indirectly, there can only be two choices for traditional players: partner with marketplace lending players, or build the capabilities, either organically or through an acquisition.
Often only financial objectives dominate a company's decision making. The draw -back to this is that financial measures typically only reflect past performance.
As these developments unfold in the marketplace, a few trends are likely to gain more prominence – where banks and financial institutions adapt from models driven by alternative lending players:
- Multi-channel lending by core platforms, and harnessing of customer, relationship and transaction data being harnessed across feeds from all channels
- Optimisation of credit process – from risk assessment, product pricing, analysis, and overall administration using robotic process automation.
- Adoption of machine learning technology and predictive analytics not just from a credit risk assessment standpoint, but also to offer customer specific products and services.
- Build the organisational model to be suited to the new age lending approaches.
As the proficiency of alternative credit improves with increased use of ‘big data’ – including social media, pictures posted, GPS data, call history, academic scores, phone updates and many other such insights – the learnings from the experiences of default and sophistication of analysis is only expected to get better. Banks would do better to proactively identify means to collaborate or co-exist, else to compete would be but a fait accompli!