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Build, Buy, Partner, or Ignore: Banking’s response to online lending

banks competing in online lending

Much attention is given to the startups in the online lending space. Companies like Propser are raising huge rounds. Acquisitions in the online lending space are beginning to become more frequent. With new investments and new companies being formed weekly, we almost never read about how banks are responding to some of the competitive pressures fintech startups are bringing to bear.

online lending and banking competition

There are basically 4 ways banks are addressing fintech competition in online lending:

  1. Build their own offerings:[x_pullquote type=”right”]Lending.com is the latest entrant into an online consumer and small-business loan market that Morgan Stanley MS -0.22% analysts estimate could grow to $122 billion in 2020 from $12 billion in 2014.[/x_pullquote]The Blackstone Group recently announced it would be setting up its own competitive offering to provide loans for consumer purchases of big-ticket items as well as small-businesses loans. Blackstone’s new platform, which will launch as Lending.com, comes shortly after news that Goldman Sachs would be doing something very similar. As lead underwriter for LendingClub’s IPO, the growth potential of online lending wasn’t lost on Goldman. When LendingClub’s founder and CEO appeared on the Tradestreaming podcast, it was clear that LC had its sights on disrupting the credit card business — it may be that online lending its an expansive move for banks and financial services firms like Goldman and Blackstone.
  2. Buy startups in the space: While we’re starting to see some of the startups consolidate and purchase other online lenders to capture market share, there haven’t been a whole lot of examples of incumbents acquiring upstart marketplace lenders. BFS Capital, a firm that’s been in business since 2002 and has leant out over $1 billion to small businesses, did make a recent acquisition as it welcomed Entrust Merchant Solutions to its growing family. As the parent company to the UK’s Boost Capital, BFS doesn’t appear to have a lot peers acquiring growth. Regulation may play a key structural role, preventing traditional banks from getting into the online lending business.[x_pullquote type=”right”]“We do practically no auto loans, no student loans, no unsecured personal loans. So as long as I have my name on those Lending Club mailers, the materials and the loans, that’s key to me.”[/x_pullquote]. Regions Bank recently disclosed a relationship with Fundation Capital
  3. Partner with the online lending startups: LendingClub has found some success in partnering with small, regional banks, with more than 200 of these players on the LendingClub platform. Small banks have, by and large, strayed away from unsecured lending, favoring mortgages instead. Partnering with online lenders enables the banks to quickly relaunch their offerings and provides the online marketplaces with partners that have deep, local roots and great direct mail lists.
  4. Ignore the future: It’s not easy to be a bank today. Regulation limits their decision sets. Competition from the bottom up is happening in fintech, where everyday, new, freshly-minted startups with sometimes hundreds of millions of dollars in backing are taking aim at the banks. Competition is happening laterally, as well as speciality financial service providers are expanding into core banking offerings. For the most part, banks struggle to keep up with the technological requirements today’s digital generation demands. While some banks may decide to “partner with the enemy”, many lack the wherewithal to rebuild their businesses within their regulatory parameters to compete against largely-unregulated competition.

While the future of banking is uncertain, one thing actually is: tomorrow’s banks won’t resemble today’s banks. Regulation will play a key role in determining in which ponds tomorrow’s banks actually fish. Meanwhile, fintech is enjoying a cold glass of white while chowing down at the fish fry.

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Why I wouldn’t want to be a bank in this market

Album_no_respectAs the late Rodney Dangerfield put it so eloquently, banks don’t get no respect in today’s market.

It’s not that they haven’t tried. Post the 2007-2008 credit crisis, many of them have cleaned up their acts.

But, it’s not just the fact that banks are now forces to lay in their own financial beds that has made bankers lives so tough of late.

Banks face (new) tough competition

It’s also about competition. Banks are being assailed on all fronts in a way they’ve never been threatened and I think the writing is one the wall: the core functions of banking are being challenged by a whole new generation of startup financial service providers that may eventually displace them. We’re in the early stages of sprinting a marathon to build the most influential finance companies.

Today’s consumer lending: from the consumer to the consumer

One of retail banking’s bread and butter business lines is a basic form of lending arbitrage. They take deposits from customers (paying out a low interest rate) and then lend it out to other customers (at a higher interest rate).

But many individuals are borrowing outside traditional banking channels. Lending Club, the largest peer to peer lender, just surpassed $4 billion in small personal loans it’s underwritten on its platform. Borrowers on peer to peer lending platforms either couldn’t qualify for loans, got worse rates with banks or just would rather avoid the banking sector all together. Banks see the writing on the wall — Union Bank just announced it would team up with Lending Club to deploy its own capital into loans on Lending Club’s website. You can hear how far the company has come since my 2012 interview with Lending Club founder and CEO.

Business loans: the next domino to fall

Lending Club made it very clear as it gears up for its own multi-billion dollar IPO (expected this year) that it’s interested in getting into business loans. It’s here, in the commercial loan business, that banks are facing their fiercest rivals right now.

  • Long term loans: Newly-minted companies like Funding Circle has already lent out hundreds of millions of dollars to business looking to borrow money for years at a time. The demand for these types of loans from non-banking sources is huge.
  • Short term loans: Businesses looking for shorter term loans and access to working capital are turning more and more to companies like OnDeck. Armed with new credit models, these firms can frequently be more quick and nimble, approving loans in minutes (versus days and weeks at traditional lenders).
  • Specialty loans: Perhaps the most interesting entrants into the online lending market are the specialty ecommerce and payment platforms. Amazon is hiring boatloads of people to staff up its new lending division. Paypal is doing the same with its new Working Capital loans for small businesses that use the payment platform. These companies are perfectly situated in their customers’ business to a) determine creditworthiness and b) to provide them with a loan. And student loans? Forget about it — there are startups like Pave (hear my recent interview with Pave’s co-founder) trying to create more efficient (and cheaper) ways to finance higher education.

Look for more innovative online lending models to proliferate in the next few years like the kind that Zazma employs. A startup that’s received investments from top venture capital firms, Zazma provides trade financing to small businesses. Need to stock up on some inventory before the holiday season? Zazma will pay your supplier for the goods and work with you on payback — all almost instantly online. Low friction like credit cards and quick access to working capital.

Today’s “no respect” for the banking sector is so much more than just the product of the recent credit crisis. Smart, well-funded startups are beginning to chip away at banks’ core value to the economy and consumers (both retail and business) seem to happier with their new-found options.

What do you think about the changes in the lending market? Let’s discuss in the comments below.