Digitization has the power to transform whole industries—not least banking, where technological innovation is among the forces behind the recent wave of profound change. Incumbents have been busy rebuilding the financial system and complying with new rules and regulations in the wake of the 2008 financial crisis. Meanwhile, fintech start-ups have moved swiftly from the sector’s periphery toward its core. In 2015, global investment in fintech companies totaled nearly $20 billion, confirming a continued interest within the venture-capital community and a growing appreciation among incumbents of the sector’s importance.
Just as disruptive as what’s happening in payments, albeit less successful in business terms, has been crowd-based lending and financing. It’s not hard to see why this space has immense innovation potential: after all, the legacy of bloated back offices and often-underinvested big data capabilities puts a major restraint on incumbent capital intermediaries. Although know-your-client provisions will probably become a bigger issue for challengers in future, LendingClub, the current market leader in peer-based lending, spends much less on credit scoring, billing, and overall compliance than established players do. But it also spends more than the average retail bank on attracting new customers and about as much as other lenders on technology.
As some banks try to reduce their balance-sheet exposure to the small- and midsize-business segment, the fintechs’ lean credit-assessment approach and lending services start to look attractive. Collaboration with fintechs could become desirable. In my view, that helps explain why crowd-based fintechs have attracted substantial attention from investors, despite their failure so far to deliver meaningful profits. According to recent industry reports, lending attracted $3.6 billion of investment in 2015, and the aforementioned LendingClub raised just over $1 billion in the largest fintech IPO of 2014. The Madden v. Midland Funding case, though, raised a question mark over the future of certain securitization practices behind unsecured consumer loans in the United States, and LendingClub shares lost half their value and have since been largely trending downward. We also have yet to see the impact of LendingClub’s announcement that it would mimic the Federal Reserve’s benchmark interest-rate decisions, including the 0.25 percent increase from last December. Overall, I see great possibilities for companies like LendingClub—but risks too, as they must address significant business and compliance issues before they can live up to their full potential.
Challenges they pose, challenges they face
Besides being challengers, fintechs face several hurdles of their own. Some stem from the current hostile market environment; others are less predictable. Take the aforementioned crowdfunding space and one of its most promising areas, corporate funding. This particular segment was recently encouraged in the United States—in every respect the world’s largest crowdfunding market by far—thanks in part to a decision of the Securities and Exchange Commission to let small businesses raise up to $50 million from the general public, in connection with the JOBS Act.