Alternative finance has seemingly burst on the scene in recent years. The movement has picked up momentum in a major way, but where did the ideas of alternative finance come from, and why have they had such a strong impact on the financial world? Here’s a look back at the history of alternative finance.
The basic idea of alternative financing is a simple one: customers should have alternative options for financial services outside of traditional banks and their high regulations and low approval rates. We have found examples of alternative finance dating back hundreds of years. Irishman Jonathan Swift influenced the Irish Loan Fund way back in the 1700s. Swift, who some have called the “father of microcredit,” established the fund to provide loans to poor rural families who had no credit history and very little collateral. The Irish Loan Fund would make small loans of 5 to 10 pounds and require weekly repayments of as little as 2 shillings at a time. Swift also required each borrower to have two neighbors as “co-signers” that would guarantee the loan if payments were missed. Swift recognized that, just because many of these people didn’t fit the mold of traditional “credit-worthy” borrowers, the vast majority of them were honest, hard-working people that would make their payments on time. These people needed financial services and he opened up a world of financial freedom to them outside of the traditional financial framework at the time. Another powerful example of alternative finance in history involves The Statue of Liberty. Crowdfunding involves pooling the capital of a number of small investors to reach a large fundraising goal. There’s no telling how far back this practice goes, but thanks to Joseph Pulitzer, crowdfunding is responsible for one of the most iconic American monuments: the Statue of Liberty. It’s a common bit of U.S. trivia that the Statue of Liberty was a gift from France, but apparently the pedestal on which it stands on Liberty Island was not part of the deal. When the construction of the pedestal ran into funding issues, Pulitzer stepped in and launched a 19th-century version of a crowdfunding campaign. Pulitzer made his case for donations to the project via his newspaper, the New York World, back in 1885. Pulitzer’s drive raised more than $100,000 in six months from more than 125,000 contributors, many of which gave $1 or less to the cause. However, the efforts demonstrated the combined power of a large group of small investors.
Technology has been one of the reasons alternative finance has been able to come alive in the modern era. The Internet Age has made it possible for fintech companies to compete with large banks better than any other time in history. Alternative finance companies, such as marketplace lenders, Zopa (2004) and OnDeck Capital (2006) began popping up in the early 2000s. However, the single biggest driver of this alternative finance wave is likely the Financial Crisis of 2008. Much of the big banks’ success has been based on their sterling reputations for security and reliability. Even today, banking executives believe that “reputation for stability” is their greatest strength when competing against new Fintech rivals.
Irresponsible subprime lending practices and risky decision-making put the entire U.S. financial system at risk when the housing bubble burst, and American taxpayers had to come in with massive multi-billion dollar bailouts for the big banks just to keep them in business. The reputation of big banks took a huge hit, and many disillusioned customers started seriously looking for alternative options for the first time.
Alternative finance has now established a firm foothold in the financial world. U.S. marketplace lenders generated $6.6 billion in loans in 2014, and the European alternative finance market reached $3.9 billion in size last year. Not only are these large numbers, the growth rates are staggering. The U.S. total in 2014 represented a 128% jump over 2013’s total, and the European number was up 144% year-over-year. It may seem like alternative finance has come out of nowhere in recent years, but a look back on history shows that the underlying principles of alternative finance have been around for centuries, and their power has been repeatedly demonstrated over time. Modern technology has allowed the benefits of alternative finance to be available globally for the very first time, and thousands of banking customers are already taking advantage of the opportunity.
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