JPMorgan recently announced a partnership with OnDeck to use the fintech lender’s loan scoring and documentation technology to service the bank’s small business clients. Big banks have been pulling back from small business lending in recent years as the cost to servicing this large pool of relatively small loans were simply cost prohibitive for banks that have to put large balance sheets to work with shrinking work forces.
This reminds me of the late 90’s when the rise of electronic trading firms began to get involved in the listed derivatives business. These were relatively small firms that were very focused on developing technology to accurately price and trade listed options on the world’s exchanges and some of the early pioneers of high frequency trading. Initially these technology upstarts were disregarded even derided by fellow floor traders who did not believe that they would create a sustainable edge against the open outcry system that had been in place for more than a hundred years.
These firms were very profitable and this derision was silenced in 1999 when Goldman Sachs bought Hull Trading for more than $500mm (Hull was earning more than 100mm per year in trading profits annually). Acquiring Hull’s trading technology was the primary goal of the purchase and it was soon propagated throughout the Goldman’s trading businesses. Goldman was a first mover among the large investment firms and their competitors soon followed with similar transactions.
The rise of electronic trading continued unabated and its impact is evident today in the nearly empty trading floors around the world. Some of these non-bank firms that lead this technological transition are now some of the biggest market participants in the world. Interactive Brokers (once known as Timber Hill), Susquehanna and Citadel Securities control a large percentage of total option market volume in the US.
But don’t be too quick in thinking that the same destiny awaits the tech lending upstarts we see sprouting up all over the world. There is a key difference between these two market places that will make the transition to non-bank lenders much slower. In the case of listed options this was a business that was exchange focused meaning all order flow routed through a central location. Attaching technology to a centralized hub of order flow where customer acquisition cost is near zero is much different than the lending market in its current state.
Market penetration rates by banks into US households and businesses is over 90%. They will control the lion’s share of customer access for the foreseeable future which is why this deal with OnDeck is so interesting. The manpower required to score document a small business loan for a bank can be eliminated with the technology found in these fintech companies. We will continue to see partnerships form between banks and technology companies the resulting efficiencies will lead to ever decreasing head counts with in the bank’s and will ultimately see an increase in profitability as resulting margins increase.
Author : Drew Froelich