Banking is necessary, banks are not

Contributed by: Aditya Jadhav, CFA, Research Analyst – Kubera Cross-Border Fund

In a world with a population of over 7 billion where 2.5 billion individuals have no access to bank accounts or other formal financial services, Bill Gates sees this as a big opportunity for technological innovation. No wonder he has said: “Banking is Necessary. Banks are Not.” Bill Gates’ quote sums up the growing irrelevance of banks in an urban consumers day to day life and the challenges faced by banks in the 21^st century.

 There will always be a need for financial services. However, the developed world is waking up to a new idea that traditional i.e. high cost banking, which has not evolved for more than century, might not be the best way to carry out financial transactions. This has resulted in the emergence of new, low cost, non-bank technological companies – called ‘FinTech’ startups – that are capable of providing financial services. The barriers to entry into financial services are now lower than ever before and FinTech companies are using cheaper and more efficient technology to challenge the profitability of the traditional banking model.

FinTech startups are attracting capital from traditional VC funds and from corporates as varied as Google, MasterCard and Intel to name a few. Global investments in these startups have increased by 14x in the last six years. During these six years, FinTech start-ups have raised $13.7 billion in 2014 through 821 deals from $930 million raised in 2008. Silicon Valley is still the heart of FinTech startups, which accounts for one-third of all global FinTech financing and 20% of all deals.

Broadly FinTech companies can be classified into sub-sectors such as Lending, Cryptocurrencies, Payments, Personal Finance etc. For the brevity of this article we will restrict ourselves to Lending FinTech. Lending has been the core banking product ever since the pawnshops’ existence, much before banks were founded. Later, with the help of sophistication and technology, banks replaced pawnbrokers. While pawnshops are still in the business of lending, they are now considered to be the last resort of the borrower. But now these borrowers have another alternative in the form FinTech companies which operates a marketplace platform, where any individual at his own discretion can lend to another borrower (peer to peer lending, P2P).

P2P lending is disrupting the business model of banks by directly connecting lenders with consumers and small businesses. Lending platforms are highly cost effective, as these P2P lending platforms have no expensive branches/legacy systems/expensive regulatory capital to service. These platforms operate at 270 bps costs i.e. 425 bps lower than traditional banking systems, which costs 695 bps as % of loans outstanding. This cost benefits are passed on to the platform users in the form of higher net yields. Simultaneously, FinTech companies such as Lendingclub.com, the world’s largest P2P lending platform is managing risk through pre-selection of loan applications.         

2014 marked the first ever public issue of a P2P lending platform, LendingClub which valued the company at $5.4 billion. Success of the LendingClub IPO was a no-brainer, as its stock was listed at $24.75 per share against IPO price of $15. Success of this IPO was followed by the public issue of OnDeck, the leading online lending platform for small businesses valuing OnDeck at $1.3 billion. 2014 was the big year for one more reason – more than $8.6 billion worth of loans were funded through these lending platforms. In the next 10 years, P2P lending will increase from $8.6 billion to around $1 trillion, according to a report by Liberum.

Some might assume that this is not a global phenomenon, but only restricted to developed nations with higher technology adoption and widespread usage of mobile internet. Analysis shows that rather this is a global phenomenon and p2p lending platforms domiciled in USA, UK, and China received 26%, 27% and 20% of global investments respectively. The world map shown below tries to capture the global FinTech companies involved in lending business.

India is not far behind when it comes to catching up with the FinTech startups trend, although P2P lending is still at a nascent stage. New Delhi-based platform LendingKart recently raised Series A funding of $10 million from VC funds. LendingKart is a company dedicated to help entrepreneurs and small businesses with working capital finance and they recently tied up with Snapdeal and Flipkart to offer fast working capital loans to their sellers. In the month of June 2015, Gurgaon based Faircent.com raised pre-Series A round of $250 thousand from Singapore based VC funds valuing company at $8 million. Statistics show that 40% of the borrowing requests received by Faircent are for the duration of more than three years and one third of the borrowed money is for business purpose.  

In a country like India with more than 30% population below the poverty line with no access to internet, P2P lending firm Milaap Social Ventures provides microfinance with the assistance of field partners. Founded in 2005, Kiva a global non-profit organization has entered India with a mission to connect people through lending to alleviate poverty. Another non-profit social venture Rang De was founded in India in 2008 to leverage the power of P2P lending to lower the cost of microcredit. It will be too early to expect any of them getting listed on stock exchanges, but you will start to notice their impact on the lending business of banks.

– AJ