[Editor’s note: This is a blog post from Garient Evans, Vice President of Client Services at ID Analytics. ID Analytics was a silver sponsor at LendIt Fintech USA 2019, which took place on April 8-9 in San Francisco.]
The LendIt Fintech USA 2019 conference in San Francisco just wrapped, and it seems like a good time to reflect on how the technology disruptors are doing in their battle against established financial institutions.
After witnessing the fall of The Yellow Pages, Kodak, and Blockbuster, tech innovators began to wonder what other industries presented an opportunity for disruption. Following the mortgage meltdown, bankers became the natural enemy for opportunistic entrepreneurs looking for the next digital coup.
By inventing a new category of software, these rebels put the “tech” into fintech and set out to reduce the inefficiencies, insecurities, and inequalities, in the lending arena. They took on the biggest and most storied financial institutions (FIs) while pundits wondered whether banks should worry about becoming obsolete, “Is it time for a financial services revolution?” “Will technology kill the bank branch?” “Will dinosaur banks disappear?”
Fast forward to 2019 and it appears that the big banks are just fine. In addition, the fintechs are still alive and well, but maybe not in their original forms. The types of fintechs discussed here are also known as “alternative lenders” or “marketplace lenders” as opposed to startups focused on block chain, or e-wallets, or other novelties in financial services. Neophyte lenders are experiencing the realities of competing against well-capitalized institutions that already have millions of customers and national reach. Instead of battling to the death, increasingly these former adversaries are joining forces.
Worried about insurgents?
The largest startup lenders have barely made a dent in the total addressable market for consumer and small business loans after more than ten years of going at it alone. In fact, banks that have been hampered by regulators in their efforts to offer loans to riskier consumers are funding those same loans as institutional investors on marketplace platforms. Why beat them when you can join them?
Who is winning “Tech vs. FI”?
I propose that the “fintech revolution” is more of an evolution. Why? Because lending is expensive, it is difficult, and it is a scale business in every way.
- Expensive – Regulations alone make lending very expensive as compared to other consumer industries. The fall of Theranos is a cautionary tale for those looking to upend highly regulated industries by appearing to innovate when in fact scamming everyone involved. Releasing a minimally viable blood test and figuring out how to bring it to industry standards later won’t work in the healthcare space just as introducing a lending app that may or may not leak a consumer’s personal data won’t work in the lending space. Developing products that are legally compliant and adequately protecting consumers requires tremendous resources and are not easily replicated in banking.
- Complicated – Figuring out which borrowers in the 550 to 650 FICO score band will pay you back, and if so, how much money should you lend them, is not a puzzle most 22-year-old software wizards will have a much experience with. Even if a fintech is able to figure out the right interest rate that will attract this type of subprime borrower, how will the lender reach these consumers? Wait, it isn’t enough to figure out the underwriting racket, now the wizard needs to figure out cost-effective, non-deceptive, targeted marketing? Yikes, this is complicated.
- Scale – Banks of any size can offer the cheapest loans to their depositors, not only because the cost-of-funds is less expensive than what fintechs can achieve, but also because the credit risk team is able to use deposit data to accurately model propensity to pay. The bigger the bank, the more difficult it will be for a startup competitor to gain share cost-effectively.
These hurdles have not prevented continued activity in the fintech sector. Banks are co-opting these technological advances either as fast followers, investors, or by gobbling up fledgling disruptors. Here are some high-level trends we are observing:
- New entrants seek to disrupt. One example of this is Vault going beyond student loan refinancing. Startups dare to specialize where others won’t, scoring funds at a record pace in furniture finance, elective healthcare and as point-of-sale lenders.
- Specialty fintech banks and platforms are getting some serious equity, such as the mobile app Earnin and the no-fees, mobile challenger bank Chime.
- Banks are investing in fintech startups so these new entrants can access the infrastructure available to federally licensed banks to originate loans. Additionally, banks are entering historically taboo areas, including U.S. Bank’s small dollar lending that offers an alternative to payday loans and BBVA’s online personal loans with potential same-day funding.
- When it comes down to it, marketplace lenders are just institutional platforms. Alternative lenders such as Avant, Upstart and Enova Decisions are becoming platforms. Payday lenders are becoming fintechs.
- FIs are buying each other faster than ever due to changes in the federal regulations that deterred deals after the financial crisis. FIs are partnering/investing with platforms and fintechs (e.g., Fundation & Provident, OnDeck & PNC, BBVA & Simple) or simply buying platforms—KeyBank purchased Laurel Road and SunTrust acquired FirstAgain. Other banks such as Live Oak and USAA are considered stealth fintechs. Last, but not least, fintechs are buying fintechs (e.g., Plaid bought competitor Quovo).
So, where will these trends take us?
While there are skeptics that banking and fintech unions will amount to much in the absence of good strategy or the appropriate culture, there will surely be changes to how FIs onboard and serve their customers.
We are in the evolutionary phase of the FI tech boom. The LendIt Fintech conference is a great resource for learning more about some of the companies mentioned above, to listen to presentations that support or refute these observations, and I invite you to reach out to me for a discussion.
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