I tend to get more passionate about this idea as the evening progresses. A few years ago, a trickle of fintech startups started offering alternatives to traditional financial services. Lending, payments, FX, savings, borrowing, wealth management were among the first targets, all of whom expanded the trickle to a flood.
Narrowing it down to lending, I recently saw a mention of 100+ P2p platforms in the UK!
Wow.
I look forward to seeing what all these sources of funding do to the cost of capital!
It seems to be an accepted reality that traditional lenders have withdrawn from SME lending and alternate lenders are rescuing SMEs from the ‘desert’ of funding. The question remains, why this ‘desert’ exists. Sure, banking culture, reticence and workflow and technology may something to do with it. But as I have advocated in the past, trading/broking margins aside, banks exist for interest rate margin. Lending is still important.
When they don’t lend, a key combination must be risk and profitability.
If the work involved in lending to a small business exceeds or is close to the effort involved in lending to larger entities, we can naturally predict where the action will be. Lack of available information, insufficient in-house financial capability (in the borrower), lack of collateral etc are well known reasons for difficult small business lending. However, there’s one area that we don’t spend much time talking about.
Regulation.
Financial institutions are burdened with it. Conduct, statutory reserves, Basel III, KYC, AML are just a few. Fintech has to deal with some of this. But not all of it.
Alternative lending proponents and fintech commentators advocate regulators leave fintech alone. If a bank won’t lend to a business at a hefty margin because it deems it a high risk of default and an alternative lender ‘saves the day’ with a high yield loan, is the bank a technology-deprived dinosaur?
Alternative lending places the burden of risk on the individual lender, whether consumer or institutional. Banks set aside risk weighted capital as a buffer against loan default. Institutional investors are likely to create their own hedges. Consumers, however, will bear the risk and reward directly.
As long as they know what they are doing, that’s fine. Many won’t understand the true cost of their funding. And some borrowers will understand, but feel lucky – the optimism that drives entrepreneurs to trade their way out.
A handful of alternate lenders in the US have started with self regulation of conduct. A good step.
Loan pricing may end up being regulated or the market will eventually find the right equilibrium. But taking a wider view, what would happen if alternate fintech had more regulation. Or conversely, we reduced regulation on the banks that left the gap for fintech to step in?