Is FinTech still the way of the future? Or is it already the past?
Grant H. Beighley and Robert M. Iommazzo, SEBA International
After attending a terrific conference recently (The Economist’s Buttonwood Gathering, this year entitled “The Valley Meets the Street”) that delved into the past, present, and future of FinTech and what it means – and could mean – for major banking institutions, we came away with many questions answered, and many more cropping up in their place.
The presenters, largely enthusiastic FinTech leaders confident in their products and large banks’ inability to deliver customer value at the level and scale they can (or will), painted an optimistic future for the ‘cottage’ FinTech industry. The unbanked everywhere, in the U.S. or Africa, will be banked; the customer will always come first; transactions from institutions large and small will be faster, less expensive, and safer than ever.
These evangelists have a strong case for their organizations and their beliefs: FinTech companies are rapidly growing: see Lending Club’s expansion into SMB lending, SoFi’s new mortgage and personal products, and OnDeck Capital doubling their maximum loan size. They’re gaining market share in consumer lending in particular, and the technologies they’re developing and implementing are blazing new trails in lending and processing, allowing more customers to have access to greater resources. These are no doubt improvements, but will these paradigm shifts become the norm, or is this simply the latest step in the evolution of mass-market banking Is over-regulation a cause for this innovation? And what will this mean for managing risks – particularly regulatory risks – in this new un-banked world?
More importantly, will these developments disrupt the big banks, or simply reshape the industry and relationships as they exist now? As we can surmise from a full day of presentations and passionate debates, it seems that there are three major considerations that portend the outcome of these late-nascency years:
A) The loans extended by Lending Club, Prosper, Kabbage, SoFi, Funding Circle, et al. tend to be at a less-than-prime level, particularly for personal loans, as banks are less eager to lend due to increasing capital requirements and regulatory demands. The loan volume is certainly not enough to raise concern on a macro scale, though as organizations extend larger lines and longer terms (while seeing a higher percentage of loans past due), are there shadows of a subprime bubble lurking in the distance? Can these risks be appropriately managed while maintaining the growth trajectory that is all but expected from these “Unicorn” organizations, particular those that have gone public?
B) As these organizations grow, they tend to look more and more like, well, banks. OnDeck Capital recently announced that it will make new term loans to business owners of up to 36 months and $500,000 – nearly identical to what banks typically extend. Kabbage is partnering with ING, a bank, to grow their business globally. From a risk perspective, if it walks like a bank and talks like a bank, should it be regulated like one, too? Will allowing innovation in risk frameworks and models spur improvements for organizations large and small, or sacrifice transparency for the sake of novelty?
C) The question remains of what happens once the market for personal and consumer loans (namely, the ones banks aren’t willing to make at the moment) is saturated, as it seems to be becoming. OnDeck Capital made half the number of loans in Q2 2015 than it did in Q2 2014, and its stock has lost 50% of its value in the past year. Funding Circle is looking to kickstart growth by purchasing smaller lenders in Europe, such as Zencap. Even Lending Club has seen double-digit percentage decreases in its loan volumes in past quarters. Will loans grow larger, will credit score requirements dive lower? Will we see firsthand why banks were so hesitant to lend to these customers in the first place?
As with all things in finance, past performance is no indication of future results. So what does the future look like for the FinTechs that are attracting so much attention?
As the industry matures, it may be that these organizations continue to fill a needed gap in the financial services industry, particularly when banks are under regulatory pressure not to lend to less-than-stellar consumers and small businesses. Should they continue to grow at their current rate, they will inevitably either accrue enough scale as to require the regulatory oversight that separates banks from other financial services organizations; that, or face the existential question (and/or realization) of what it is to not be a bank.
The third, and, in our view, most realistic option, is that they’ll partner with the banks (or be purchased outright) as they continue to grow their scope and scale. Banks can either a) provide the backing for larger-scale lending operations and the scale for geographic growth (all while meeting regulatory standards and having the risk/compliance teams in place to ensure stability), or b) leverage the proven technology and platforms created by FinTechs to redefine banking as we know it.
The question of the day at the conference was whether banks would still exist in 50 years. History and current trends lead us to believe that they certainly will – they’ll just look like FinTechs.