Could Lending Startups Disrupt 1,000 Years of Banking?
Disrupt or be disrupted, right? Well, try telling that to the innovators of startup businesses in the extremely challenging financial services space. According to a report by the U.S. Federal Reserve, a typical small company in America spends 24 hours applying for loans. That's a full day's worth of work.
The pay-off, unfortunately, isn't as impressive. According to the Fed, just 33 percent of these startups receive all the credit for which they've applied. Some 45 percent of companies are denied loans altogether. We keep hearing that small, innovative startups are the lifeblood of any economy. That's because they grow into large companies and employ lots of people.
But since the global economic crisis, large banks have scaled back their loans to small businesses and entrepreneurs. The reason? There's simply not enough incentive for them to stick their necks out and risk capital on these small companies. They have instead focused on making big loans to big entities with the knowledge that they'll be paid back with lots of interest. That is how a bank makes money, after all. Who can blame them?
The way most of the world's banks operate really hasn't changed much in the last millennium. In the Western world, they lend money and the party that is the recipient of the loan repays it with interest. But banks' tolerance for risk has decreased dramatically in the past few years. What's fascinating is that as they have scaled back their lending, they created a vacuum into which a number of smaller financial services firms have sprouted up.
This vacuum is important when you consider the fact that small- and medium-sized enterprises (SMEs) constitute almost 90 percent of all enterprises globally. In the United Kingdom and South Korea, 99 percent of all enterprises are SMEs. SMEs account for more than half of all job creation in most countries: nearly 80 percent in Germany and nearly 88 percent in South Korea. These innovative enterprises contribute more than 40 percent of the GDP of many countries: some 40 percent of American GDP and 75 percent of German GDP.
One of the most interesting of the financial services companies to cater to these SMEs is Lending Club. To be sure, Lending Club has been around for a while. It started by taking advantage of digital tools and embraced crowdsourcing. It essentially matched up parties that were looking for loans with parties that were willing to lend the amount to them. Now, however, Lending Club is focusing on the small business space as well. The company, not unlike other firms such as Bond Street, Funding Circle, and Fundation, uses Big Data to analyze the potential recipients of loans and matches them with entities that are looking to lend money or take a stake in a new, innovative startup. These entities might be single, wealthy individuals or even hedge funds looking to diversify their portfolios.
One of the most interesting activities of late is the formation of a new financial services company known as Affirm. It was founded by Max Levchin, one of the co-founders of PayPal. He looked around and saw that an enormous portion of the population under a certain age were awash with student debt. Debt collectors and big banks will do whatever it takes to get that money back, so younger consumers naturally have a sort of mistrust of big banks.With Affirm, Levchin aims to underwrite the loans of younger consumers. He describes the company in a recent interview as an "attempt to build a bank the way it should be done in the 21st century." Indeed, 'aggregation' is the new business model. It's where a company doesn't need to own an asset or liability but rather bring together the interested parties on a common platform and facilitate the transaction.
Another innovative entrepreneur is Sean DeClercq, the founder of Kickfurther. He uses crowdfunding to represent small distributors and retailers en masse and buy inventory. Those firms can choose the rates and duration of financing to meet their needs. Kickfurther came right out of a small business accelerator - just the kind of success story those accelerators want to hear.
What all these startups have in common is that they're using digitization in new and unique ways to make connections between entities that have money to lend and entities that need money to get off the ground. What will be a stamp of approval of sorts is if they become successful enough to attract the attention of the large, global banks - the ones that are sometimes deemed 'too big to fail.'
If big banks see that crowdfunding loans is profitable enough, you can bet that they'll enter that space with the intent of smashing the small startups to bits. That's one of the advantages of being too big to fail - you can wait and see how the risk-taking startups fare in new lines of business like loan crowdsourcing.