Editor’s note: David Klein is the CEO and co-founder of CommonBond, a student lending platform that lowers the cost of education for borrowers and provides financial returns to investors.
“Banking is necessary – banks are not.” Bill Gates said this in 1994. It was a bold statement to make at the time, and one that some have associated with the start of a transformation in financial technology.
Now, two decades later, we are seeing this revolution unfold before our eyes. Catalyzed in large part by the financial crisis of 2008 and 2009, a new financial order is emerging. It is one where large, traditional banks are increasingly facing heavy competition from new entrants – namely, online marketplace lenders – that are delivering a more human lending experience through the technology, transparency and trust that consumers want from their financial services providers.
In a March report titled “Future of Finance,” Goldman Sachs analysts Ryan Nash and Eric Beardsley noted that regulatory changes and new technologies are among the top factors reshaping the traditional banking sector and enabling the rapid growth of marketplace lending.
Regulations instituted after the financial crisis have measurably impacted the work of traditional banks. Legislation such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, the financial regulatory reform bill passed in Congress in 2010, combined with evolving bank capital standards, have lowered returns on equity for certain products. Banks have been forced to respond by either raising prices or shrinking various businesses.
To put into perspective just how hamstrung banks are by regulations, a senior executive at a top U.S. bank told me that he spends about 75 percent of his time these days dealing with regulatory matters. Just two years ago, that number was 10 percent.
The regulatory environment banks are facing has created a big opportunity for new entrants, especially in the area of consumer lending.
The Goldman Sachs report notes that in addition to fewer regulations, technology has become one of the most significant enablers to entry. The combination of big data analytics (Prosper, for example, goes far beyond the scope of the FICO score by looking at more than 400 data points in determining a borrower’s credit score) and new, online distribution channels has allowed fintech start-ups to disrupt traditional banks. Marketplace lending platforms benefit from lower-cost bases than traditional banks, primarily driven by exclusively online businesses, versus the branch-heavy businesses of banks.
Above all else, marketplace lenders are serving consumers by giving them exactly what they want: customized products, streamlined technology and responsive customer service – while traditional finance companies are not.
Newer entrants are also serving areas of the market that are not adequately being tapped by the traditional incumbents. One of my favorite statistics, from the Millennial Disruption Index, says that 71 percent of the millennial generation would rather go to the dentist than listen to what traditional banks are saying. Further still, 33 percent believe they won’t need a bank at all. More and more, millennials and others are turning to marketplace lenders to meet their financial needs.
Charles Moldow, a general partner at Foundation Capital and one of the industry’s key voices on marketplace lending, recently wrote that “marketplace lending will increasingly encroach upon – and take market share from – traditional banking.” He added, “I believe this will happen across lending (consumer, real estate, SMB, purchase finance), payments, insurance, equity and beyond.”
Traditional banks now have a couple of choices to make:
- adopt the central tenets of marketplace lending (well-priced products, intuitive technology and top-quality service with a relentless focus on the consumer);
- partner with the disrupters; or
- be relegated to the shadows as marketplace lenders continue to take market share.
If banks choose one of the first two options, their relationship with marketplace lenders can be a symbiotic one. A convergence of “old finance” and “new finance” can take many forms, from coexistence to consolidation.
“Old” and “New” Finance Converging
We’re already starting to see traditional finance and emerging finance come together, taking the best of both worlds, to make finance better for the end consumer. Look at the partnership announced earlier this year between FundingCircle and RBS to give thousands of small British businesses greater access to finance.
Or look at the even more recent partnership between Lending Club and Citigroup, in which Citi will use Lending Club’s platform to supply up to $150 million to underserved borrowers and communities that its branch network is unable to reach. Convergence is happening, and it will likely continue. In the end, the consumer will win.
Marketplace lending is humanizing finance in a big way by responding directly to the needs of consumers. Rather than viewing their relationship with borrowers as a one-time transaction, most marketplace lenders are treating it as a long-term relationship, in which they build trust and set the stage for many more future interactions – interactions that consumers appreciate and even enjoy.
I see a world in which financial products add more value to people’s lives and become easier to understand and interact with. Financial decisions will become simpler to make, and we will be more in control of them.
It’s clear that banks must now contend with a big emerging force in the financial world. It is up to them to decide whether they are in or out – whether they want to acknowledge, engage and collaborate with newer entrants in the marketplace lending area, or not. Because, when it comes to serving consumers in the best ways possible, there is no in-between.