A wave of lending start-ups with innovative financial technology at their core and with a single minded motive to facilitate small businesses and consumers have taken the lending sector by storm all across the globe. Post-2008 financial meltdown, these startups have grown both in size as well as in numbers at a breakneck pace. The rise of fintech can be gauged from the fact that in a survey by PWC, around 50 percent of the financial services firms shared that they plan to acquire fintech companies in the next three to five years and almost eight out of 10 institutions plan to strike strategic partnerships with P2P lenders.
Fintech Industry in Numbers
The year 2015 was a record-breaking year where fintech companies were able to raise $19 billion. But 2016 proved to be even better as the financial technological start-ups managed to raise $36 billion in financing across more than 1,500 deals from 1,700 unique investors. The most popular segments were the payment/loyalty/e-commerce segments, which took almost 40% of the total funds raised, followed by the banking and lending segment.
Why are big banks worried?
According to a recent study, nearly $11 billion in lending profits are at risk over the next five years. For decades, banks have been following and relying on their “loss leader pricing strategy.” Essentially, they provide certain basic products like checking accounts at a price below the cost. This is done to entice customers to avail more profitable products like loans. But now, fintech companies are taking away the profitable part of the business from banks and leaving banks with high overheads and low-profit margins. The shrinking bottom line has banks worried and weighing various options like high charges for bank accounts, acquiring fintech start-ups, or partnering with fintech lenders.
Different approaches used by the banks
In a recent research study by PwC, it was found that 30% of consumers plan to increase their usage of non-traditional financial service providers, and only 39% plan to use traditional banks alone. This has prompted banks to act swiftly. Hence, a lot of partnerships recently have been struck. A few notables include JP Morgan’s deal with OnDeck Capital and Digital Asset Holdings; Kabbage’s partnerships with Santander, Scotiabank, and ING; and Funding Circle’s deal with Santander. The earlier approach of fighting it out with startups or ignoring them has given way to respecting their specialization and realizing that both can thrive using each other’s strengths.
Apart from strategic partnerships, big banks and other financial institutions are using their superior financial power by buying out or investing in fintech lenders. A report by TechCrunch states that “BBVA, Credit Suisse, and JP Morgan have directly invested in Prosper’s latest funding round while Silicon Valley Bank and Norwest Venture Partners (Wells Fargo is the sole LP for Norwest) have invested in Lending Club.”
Banks have also started setting up their own innovation hubs across the globe in their endeavor to launch more innovative products or services. Goldman Sachs recently launched its fintech arm known as Marcus, which will compete with the likes of Prosper and Lending Club. Chase, Wells Fargo, and Bank of America have all set up their own innovation labs in order to compete with new age fintech competitors.
Win- Win situation for both parties
Banks have years of experience and a huge database of customers to draw upon, but they struggle because they don’t have the agile infrastructure needed to meet the ever-changing needs of customers. Having said that, banks have managed to build trust with customers, have well-established regulatory and security frameworks, and are well acquainted with government compliance policies. The most important thing banks have is deep pockets and an ultra-low cost of funds.
On other hand, Fintech companies have made a major splash in the market but have only managed to take a small portion of the lending pie. Another issue is they are able to tackle only one pain point at a time rather than a range of services offered by the brick-and-mortar banks. Though Fintechs have entered the mainstream, partnerships seem to be the fastest and easiest way to move forward for both banks and fintech lenders. Fintech startups can bring their in-depth knowledge of big data and understanding of the nerve points of digital-first customers while banks’ legacies in branding and low-cost funding availability makes this a marriage made in heaven.
Through these partnerships or acquisitions, banks will also be able to tap into the millennial population. The majority of the younger generation has a perception that banks are old-fashioned and unhelpful whereas fintech is considered as smarter and convenient. Considering this generation accounts for 80 million prospective borrowers in the U.S. alone, banks cannot walk away from such a massive consumer segment.
The lending industry is witnessing the dawn of a new era. You have startups helping trillion dollar lenders become nimble and offer a seamless lending experience across all digital platforms. You are seeing banks as the lending partners of technology platforms whose cost of borrower acquisition is a fraction of the bank’s marketing costs. Fintech lenders are associating with credit unions and community banks and helping them tap their own existing customer base for up-selling and better conversion. It is vital for traditional banks to accept that fintech has helped the lending business evolve into a new landscape. They need to adapt or be ready for disruption by other banks who are striking deals with fintech lenders for growth and survival.
Written by Heena Dhir.