The fintech space is exploding in popularity and alternative financing -- a 21st century solution to traditional credit -- is blossoming alongside it. A recent report from the Economist Intelligence Unit reveals that more than $25 billion has been invested into fintech companies over the past half-decade, making it the most popular destination for venture funding. And many of those investors are backing some of AltFi’s most disruptive players, like Upstart and Prosper.
What got us here
Out of control lending in the traditional banking space is one factor that got us to this point. An overabundance of subprime mortgage loans, concealed by high home prices and buoyed by securitization, were a chief driver of the last Financial Crisis. As a result, U.S. regulators were forced to enact an array of new regulations to ensure lenders wouldn’t threaten the country’s financial system again. In the aftermath, new regulations placed on the financial markets included Dodd-Frank, Basel III, Basel II/II.5 and the Card Act. These bills have also stifled traditional banks’ appetite to lend, and the stats are clear: Since 2009, the total amount of revolving credit in the U.S. has declined by nearly $1 trillion. Between 2008 and 2012, traditional small business lending in the U.S. fell by a whopping $120 billion. According to Mercator Advisory Group analyst Alex Johnson, another reason customers are flocking to alternative lenders has to do with technology. “In my research, I found that the answer is less a matter of pricing (as many assume) and more about providing the fast, digital-centric borrowing experiences that today’s consumers want,” he explains in a blog post. AltFi customers appreciate the transparency of the borrowing process, the hands-on control they have over the process and the ease and speed of using the technology involved.
Lower rates: A third factor
A third factor boosting the AltFi space has to do with interest rates. Minimal overhead expenses -- in other words, increased efficiency -- allow marketplace lenders to pass those savings on to the consumer. Companies like Lending Club, for example, have hundreds of employees operating an online infrastructure without the need for physical branches. "Our innovative marketplace model, online delivery and process automation enable us to offer borrowers interest rates that are generally lower on average than the rates charged by traditional banks, credit cards or installment loans,” the company explains in a recent SEC filing. There are several laws that apply to both banks and alternatives alike, including SEC oversight, but lighter regulations also let alternative lenders keep costs down. Unlike banks, marketplace lenders are generally not subject to the same capital requirements, according to Morrison Foerster’s Ze’-ev Eiger.
A natural evolution
New regulations, along with technological improvements and lower rates for some, have allowed a natural evolution to take place. Sites like LendingClub Corp (NYSE: LC) and On Deck Capital Inc (NYSE: ONDK) have now become household names after stock market IPOs, while student loan-focused SoFi plans on going public within the next year. What’s more, many of Wall Street’s biggest names are supplying the gunpowder for the boom. Prosper,with a valuation above $1 billion, has funding support from JPMorgan Chase, Credit Suisse, SunTrust and Neuberger Berman. Barclays Accelerator is also heavily invested in the space, while Citigroup and Goldman Sachs have made 26 different bets on fintech companies since 2009.
So...just how big of a threat is AltFi?
New survey data from The Economist shows 70 percent of bankers believe fintech will disrupt traditional lending in the future. And more than half of respondents think banks aren’t doing enough to keep a competitive advantage over new alternatives. In 2011, Lending Club issued $258 million in loans. By 2014, that number had grown to $4.4 billion. Business-related alternative financing in the U.K., which has a larger market than the U.S. on a per capita basis, is projected to grow ten-fold by 2020. While one might assume that the vast majority of this growth has come from the 88 million or so under-banked Americans, Lending Club actually requires a minimum FICO score of 660 for its borrowers. That said, other lenders like fast-growing Avant Credit focuses on lower areas of the credit spectrum.
One simple truth
This means that the AltFi revolution is not just being driven by below-prime customers banks no longer want. It’s also being driven by qualified bank customers who are making the decision to take their business elsewhere.
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