These are challenging times for the incumbent heavyweights of the financial services sector. Beset by regulatory, governance, technological, capital, and investment issues, they are increasingly facing competition for business from a whole host of new players, primarily from 'FinTechs'.
Growth of marketplace lending
In the case of online lenders, this trend began in the UK in the mid-2000s when Zopa, the world’s first digital and now Europe’s largest peer-to-peer (now called marketplace) provider, launched, quickly followed by the likes of Prosper, Lending Club, and OnDeck in the US.
Eleven years on, Zopa has lent around 1.8 billion pounds to more than 150,000 borrowers funded by 63,000 investors of whom 53,000 are said to be active participants into its lending marketplace.
The US players have had a similar impact on the US home market by exploiting a sector of the financial system not previously well-served by the banks. Prosper, for example, has originated $US7 billion of funded loans while Lending Club, now the world’s largest marketplace lender, has provided in excess of $US20 billion in finance for personal and business loans.
This growth hasn’t been without problems. Lending Club has been hit by internal governance and management troubles over the past few months, while Prosper and OnDeck have had to curtail their operations amid concerns about the state of the US consumer credit market.
But what all of these new-style lenders have shown over time is that there is a demand from consumers, previously wedded to their banks as their primary financial provider, for the new generation products they offer.
These companies have enjoyed relative success by targeting particular segments of the consumer finance market where the speed of their digital service, offers of better customer experiences and, in the majority of cases, lower interest rates have left traditional lenders unable to keep pace. And just last week, Lending Club announced it was moving into re-financing car loans to exploit that sector.
Developments such as these have prompted different responses from established players and led to questions from boards, analysts, and investors as to whether banks should compete head-on or collaborate with these upstarts to protect their existing markets.
Fighting digital entrants on their own turf
A competitive response requires legacy companies to fight on the terms that gave rise to the FinTechs in the first place. Take, for example, the launch last month of Marcus, an online small consumer loans platform from Goldman Sachs in the US designed to take advantage of a market grown by Lending Club and Prosper.
Collaboration between the old institutions and the FinTechs varies, from taking part as shareholders or providers of seed capital to becoming loan funders and referrers of customers who the banks, for instance, can’t or won’t serve.
But until the new players get scale in terms of total business and customers, it’s not surprising that the banks, particularly the major ones with their dominant market shares, have tended to be slow to react.
Big Four understand benefits of digital collaborations
This appears to describe the current trend in Australia, where the entry of marketplace lenders like SocietyOne from 2012 onwards added new competitive pressure to the Big Four banks and other traditional lenders in areas such as personal loans, car finance and SME lending.
That pressure, while low level at the moment, is real, according to Ernst & Young’s 2016 Global Consumer Banking Survey released a couple of weeks ago.
Ernst & Young surveyed 55,000 people globally of whom 40% indicated they were becoming less dependent on a bank as their primary financial services provider and were increasingly excited about what alternative finance companies could provide.
While initially slow to respond, banks certainly understand the threat posed by the digital era. In the latest annual results announced by NAB on 27 October 2016, management devoted several slides in their investor presentation pack to improvements to their digital banking services to help compete with those offered by new players.
What has been interesting, though, is the increasingly two-pronged approach taken by the big banks in Australia to collaborate with start-ups and their investors as part of an ‘if you can’t beat them, join them’ strategy.
Westpac kicked that off in a significant way when it created the first retail bank-owned venture capital fund, Reinventure, in 2014 with the aim of backing and learning from digital disruptors, primarily in the financial services sector. It made available an initial $50 million and has since topped that up by the same amount.
From its first investment, in SocietyOne, Reinventure now owns stakes in 13 start-ups including payments platform PromisePay, secure bitcoin platform CoinBase, and SME lending marketplace provider Valiant.
Westpac has since taken a direct stake in new online mortgage lender Uno and also refers customers to the digital SME lender Prospa (not to be confused with US Prosper). The Commonwealth Bank has the same arrangement with small business loan provider OnDeck in Australia.
As for NAB, it recently set up its own venture capital fund NAB Ventures with $50 million to invest in start-ups while the bank teamed up with Telstra in June this year to launch a new SME-dedicated platform called Proquo.
Small business has been the target too for ANZ, which at the start of 2016 partnered with technology-led Honcho which helps new SMEs to set themselves up through the registration process. ANZ also has a tie-up with a Melbourne start-up incubator called York Butter Factory.
Mutually beneficial arrangements
But it’s not just the major banks who see benefits in co-operating with FinTechs. Mutual banks and credit unions, who have seen the proportion of their total lending book made up by personal loans slide over the past 20 years from 52% to just 8% now, are teaming up with new companies to tap back into this market as a new growing asset class.
Customer-owned groups like G&C Mutual Bank, Beyond Bank Australia, Regional Australia Bank and the Maritime, Mining & Power Credit Union are doing that in two ways: as equity shareholders and as direct investor funders (with other credit unions) of borrower loans where the returns are currently averaging 10%.
This sort of collaboration shows how digital disruption can benefit incumbents and create value, despite understandable investor concerns that the opposite is likely to occur.
Danny John is Director of Communications at SocietyOne and a former Business Editor of The Sydney Morning Herald. SocietyOne is a sponsor of Cuffelinks.