How online lending is changing bank competition
Technology has a habit of disrupting markets. It transformed most aspects of media production and distribution, is currently upending the transportation market and shows no signs of stopping. As venture capitalist Marc Andreesen said in a 2011 Wall Street Journal article, “Software is eating the world.”
Finance is the next industry on technology’s radar, and financial technology (FinTech) is already beginning to shake up a core part of the financial services sector: lending. Online companies are providing a healthy source of bank competition.
Online lending is growing quickly as a response to a gap in the economy. Small businesses typically find it difficult to secure the types of small-dollar loans necessary to sustain and drive their business. They are now turning to online lenders as a form of bank competition and can even apply through mobile devices. How should banks respond, and how can customers capitalize on these changes?
The research and paperwork involved with bank loan applications is cumbersome, taking an average of 26 hours, according to a report from the Federal Reserve Bank of New York. In 2015, only 45 percent of small companies applying for loans received all the funding they needed, according to the Federal Reserve Bank of Cleveland’s 2015 Small Business Credit survey.
This may not represent an existential threat to banks now, but they should be taking notice. A March 2016 report by Aite Group revealed that online lenders have doubled their outstanding portfolio balances each year since the mid-2000s. Over a quarter (26 percent) of small businesses surveyed by Aite said they would “definitely” or “probably” consider sourcing loans from online sources instead of their banks.
Online lending has evolved as a more nimble option, and Harvard Business School’s 2016 State of Small Business Lending paper broke the category into several types of lender, including the following:
- Online balance sheet (institutional) lenders
- Peer-to-peer lenders, backed by individual investors
- Commission-based marketplaces that aggregate lenders, serving as comparison shops for those seeking a loan
These categories are increasingly merging together as online lending companies evolve and mature, representing a viable alternative to banks.
How can banks adjust?
Online lending has grown quickly, and banks have been forced to address the problem, the Harvard paper said. It suggested four ways in which banks should combat the online lending threat:
- Cooperation: Banks can cooperate with online lending platforms at arm’s length by referring small or rejected loans.
- Integration: By folding these new online lending services more tightly into their own operating and compliance systems, banks can shore up the gaps in their own traditionally more cumbersome application processes. This has been seen in both smaller and larger banks. American Banker reported that Berkshire Hills Bancorp partnered with Baker Hill to streamline its loan processing operation, slashing its underwriting time from 2,500 minutes to 125. JP Morgan has partnered with online lending firm OnDeck to provide near-real-time loan application processing, according to Bloomberg.
- Reinvention: Banks confident in their ability to match nimbler partners can invent their own platforms altogether and try to own the service themselves. This approach is taken by Eastern Bank, which launched its own online lending product using its internal “Eastern Labs” development, reported the Boston Business Journal.
- Investment: Banks increasingly run FinTech venture capital arms that invest in emerging technologies. Backing young online lenders is a way to take a stake in these companies and monitor their growth. For example, BetaKit reported that consumer-focused online lender Borrowell sourced Equitable Bank as an investor in two rounds.
How can businesses benefit from the shifting landscape as banks and online lenders tussle with each other to secure a place in this vibrant market?
The increased market competition puts customers squarely in the middle of the conversation, meaning banks will be forced to revamp their working practices and make customer convenience a priority. Businesses can explore their own banks’ efforts in this area and turn to a range of other options if they don’t believe their financial institutions are moving quickly enough.
Ultimately, banks are unlikely to be existentially threatened by online lenders, suggested Deloitte in an analysis of the UK lending marketplace, which has similar implications for other regions. Thanks to their deposit holdings, banks are able to source their funds at a lower cost than most marketplace lenders, and relatively few people will be willing to pay a premium to quickly access loans. Furthermore, the uncertain regulatory position of online lenders may also give customers pause.
However, that doesn’t mean banks should be complacent, Deloitte added. Online lenders may present banks with an opportunity, but they “have more to gain than to lose” from partnering with marketplace lenders. A healthy spirit of cooperation and collaboration can only benefit small-business customers eager for low-cost, convenient funding.
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