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When Banks and Fintech Collide

Date: Jul 19, 2016 @ 07:00 AM
Filed Under: Banking

All things evolve. Living creatures evolve, whether they are people and animals or plants: They change to adapt to their surroundings. Structures can evolve too: A home is expanded to meet the needs of a larger family, while a building -- like the one next to my office -- can be transformed from vintage 1930s commercial office space into a 21st century hotel, complete with several new floors.

Ideas evolve as well and we in the financial industry are witnessing the evolution of a very big idea right now.

The idea, as it was formulated a decade ago, was that small businesses needed an alternative to traditional banks and credit unions. These financial institutions moved too slowly and their applications were too labor intensive for small businesses, which often did not have a lot of long-range visibility into their financial needs, or the staff to prepare requests for capital. Small businesses often needed money fast and they did not have the time -- or the appetite -- to spend hours preparing an application, only to have it rejected.

Enter the Internet. The Internet was already transforming the global economy from the gathering of raw materials to the supply of consumer and business services. Why couldn’t it transform financial services along the way? Alternative finance companies rose up to do things that banks couldn’t, and during the recession, when it became almost impossible for banks to serve small businesses, alternative finance often seemed to be the only way for small business to get the capital they needed.

In the ensuing years, some people in financial services tried to portray alternative finance and traditional banks as mortal enemies. They tried to insist there was a revolution afoot and only one approach to lending would survive.

It’s not a revolution. What financial services has been going through is an evolution. Each side is learning to adapt and, like the evolution among so many natural phenomena, the leaders on each side are finding a way to coexist with the other.

There are multiple reasons for this evolution, from market conditions to regulatory revisions.

Let’s deal with the latter first. Regulation comes to every industry eventually, and there will be no exceptions for alternative finance. The federal Consumer Finance Protection Bureau and several states are already working on initiatives, and I welcome them. I’ve said repeatedly, in bylined pieces and conference roundtables, that properly crafted regulation at the national level will be a benefit to the leading alternative finance companies because they have the potential to lift a fog that can seem to surround our operations. The traditional finance industry understands the rates charged by alternative finance companies are the product of the credit risks they assume, but the general public -- and some small business owners -- have too often been unsettled by higher rates than those charged by banks. A lack of transparency in the operations of many alternative finance companies has fostered confusion and mistrust, which are prime drivers of regulation.

Then there are the market forces. One of the biggest challenges alternative finance has faced, and from its very early days, is customer acquisition. The companies in my industry are spending significant portions of their budgets identifying small business prospects and marketing to them. We’re buying keywords, running direct mail campaigns and creating radio, TV and print spots to get the word out.

The cost and complexity of customer acquisition will prove overwhelming for some of the still-young companies in the alternative finance industry. They will not be able to secure the public or private capital needed to invest in marketing; they may find themselves unable to master the nuances of the field. Perhaps worse, if they spend internal capital, it will drain funds away from the investments they could make in promising underwriting assessment models or the analysis of data, structured and, increasingly, unstructured. Chasing customers could chase them right out of business.

Banks have customers, even if they don’t always want to lend to them. They probably had the personal checking and savings accounts of most long before those customers became small business owners. The names of traditional banks and credit unions are familiar to those customers when a relationship officer calls or emails.

Time and again though, banks can’t lend to these customers. With their high overhead, it doesn’t make economic sense, and I’m not the only one seeing that. At its Small Business Banking Conference last year, the industry publication American Banker said a traditional bank will lose money on a $100,000 loan. Most small businesses, however, aren’t looking for a $100,000 loan; they usually want far less, often $40,000 or $50,000. It’s no surprise then that most don’t get it from a bank, even if that bank also has their other accounts and their mortgage: For most banks, loans that small are a money-losing proposition.

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