THE FINTECH PARADOX IN ONLINE BUSINESS LENDING

Technology is meant to be a productivity enabler whatever industry it serves.  The media and investment bankers are so keen on nicknames that they cannot help from creating neologisms to define new sectors or industries. A technology driven sector has to be named SOMETHING-TECH. Playing with words usually helps simplify complex concepts, until it just delivers the opposite, creates bad publicity and counter-productivity.

Most of the time, the INDUSTRY+TECH association conveys a positive connotation. Some companies called themselves likewise. Chemtech International, for example, is a global solutions provider for the manufacturing needs of various industries. Autotech defines various services to the car owner or industry, whether it is tuning, or innovative solutions to the auto industry. However, type Fintech and you will learn that it refers to “companies that use technologies and innovation in order to compete in the marketplace of traditional financial institutions in the delivery of financial services”.   With Finance, it is therefore different, and to make matters worse, Fintech is also referred as “Alternative Finance”. This stigmatizes an arrogance that is hard for banks to tolerate.

There is a good reason for banks to dislike Fintech.  It is the media and investment bankers banging the news on how much cooler and smarter they are at a time when high IPO valuations were needed, while banks were still trading below book value. Fintech’s debuts enjoyed being portrayed as leaner and smarter while banks were and often still are referred as dinosaurs, slow to move and improve service through innovation. Fintech companies and banks started off on the wrong foot; the media loved it and made the Fintech into the new alternative to legacy finance, de facto a business threat for banks.

The term “FinTech Lenders” was also a play to bring TECH multiples to online lenders who leveraged technology to automate many of the labor intensive repetitive processes endured by the traditional lending process. The term “alternative lending” was brought out as a way to label and define something that wasn’t traditional and wasn’t done through traditional sources (ie: Banks). After all – everyone loves newly created words defining disruptive technologies with the thought of abolishing old and tired processes full of bureaucratic rules. While the term “Fintech” may help people to understand the industry segment of interest or a specific vertical within the industry, it should not be used to primarily define lenders who leverage technology in a new and improved way.

The paradox of all this: Fintech offers innovative solutions to legacy financial institutions but its names says something else. Also, banks being so glacial early on, Fintech may have had no other chance but to try their technology for themselves, enforcing the alternative force within them! With a few years in business, some Fintech have been able to demonstrate the need for their product by generating strong demand. Small business online lending is a proven case with billions of dollars of loans made since the credit crisis.

However, not all Fintech business models have yet matured into profitability, key to the definition of success. A structural element of future success for new entrants resides in their ability to access cheaper funding and quality customers. Who can offer these things?  With that in mind, Banks, especially small ones, should feel confident they can monetize their position to bring down their cost of innovation.  By working with innovative companies in financial technology, they can quickly benefit from new and very cost efficient ways to grow revenues. Online lending could be the first expertise to explore in order to welcome small business back and help them grow.

It is true that technology has enabled new entrants to offer innovative services not available at banks, either as a product offering or at a more competitive price.  It is also true that banks have been slow at embracing technology as a growth engine, mostly due to lack of capital to fund innovation. This is especially the case for smaller banks who tend to lack financial and human capital to invest heavily in R&D and innovate. Large banks with deep pockets have found ways to either build or partner and grow their presence in areas where technology offer a clear competitive edge. Large banks have in fact recognized the win-win rationale for partnering with Fintech, an opportunity also open to small banks. Large banks love Fintech because they can afford it. Small banks can as well.

In the case of small business lending, these new online lenders saw a void left by banks in micro-lending (below $150,000 uncollateralized loans) and used technology to reduce underwriting cost accordingly. Online lenders did not actually steal market share from banks in micro lending. Instead, they offered an economical solution to underwrite small loans and managed to fill a gap left by banks.

How will the paradox divide disappear between banks and Fintech Alternative Lenders?  It will dissipate with the online lender taking time to educate banks about their efficient loan platforms and how they can help banks reach new customers, develop new funding sources and grow revenues, especially non-recourse fee income.  Banks should also be curious and consult with online lenders to better define how they can benefit from their technology and expertise in lending small.

Online Lending could be merely defined as – technology enabled lending through a secure website and internet based process. It doesn’t really stop there. Many “online lending” platforms are little more than a pretty form fill website application. The real battle is won (or lost) on the battlefield of cost-to-produce.

What happens after a business loan application is submitted online?

  • Processing workflows
  • Multi-database connectivity via API’s
  • Underwriting processes including risk scoring
  • Anti-fraud detection processes
  • Efficient client interactions
  • Comprehensive and effective post loan funding servicing
  • Post loan funding automated surveillance

This is where the “cost” rubber meets the road.

The total cost of the customer acquisition, headcount and operations to support the online lending operation.

Many online lenders require hundreds of employees behind the scenes to run their “automated processes”. Applications processed per employee, funded units per employee, total cost to produce in basis points. These are traditional metrics that hold true for traditional lenders and online lenders alike.

Now in analyzing these metrics and using units instead of dollars, allows to level the playing field from traditional lenders with 7 figure average loan sizes to online lenders with 5 figure average loan sizes. Profitable online lenders will be the ones who have shared their technology with small banks, and by doing so, help solve the circle quadrature: through partnerships with banks, provide small business with no collateral capital to grow.  An online lender who has been working tirelessly for years optimizing its processes, risk scores, data aggregation processes, headcount metrics and servicing techniques is a great match for any bank that genuinely seeks to lead its local business community towards growth and prosperity.

Fintech is good for banks who can see and exploit the opportunity. In fact, banks who take the lead in partnering with online lenders are the ones who can ensure that online lending becomes mainstream for very small business in North America.

0 replies

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *