Silicon Valley is coming. There are hundreds of start-ups with a lot of brains and money working on various alternatives to traditional banking. – Jamie Dimon
For a chief executive of one of the largest banks in the world to make the above statement, there must be something going on. In this piece, I would humbly attempt to give a perspective around the lending scenario in the
Banking is one of the oldest industries in the world, the first mortgage was actually issued in Britain in the 11th Century and from then it has seen its ups and downs, seen centuries of change, seen monarchs and world wars but banks have survived as institutions that customers trust and value closely. This has also been the reason why as a sector I believe it’s probably been the most resistant to disruption by technology. Banks have built robust large businesses with multiple barriers to entry: Omnipresent distribution through branches which have been part of all of us growing up, unique expertise such as credit underwriting underpinned both by data and judgment, the regulated environment in which they operate and the importance of the same to the overall economy, and of course the government backing in case something goes wrong. Moreover, consumer inertia in financial services is high. Consumers have generally been slow to change financial services providers. Particularly in developed markets, consumers have generally stayed loyal towards the established and ever present brands in banking and insurance. Even in the context of Independent India, the above holds true, initially with the presence of state run banks and then as the economy and the sector opened up, presence of private and MNC banks set up and run by top notch brains of the country which are household names and strong brands with high recall as we see and transact with them pretty much every day.
So with so much going in favour of banks and the importance of the sector per se, why this hullabaloo around Fintech and
The historical entry barriers which the banks have enjoyed over centuries are diminishing so while they continue to remain critical for the global economy, largely hold a monopoly on credit issuance and risk-taking; continue to hold deposits and wealth of most people in the world, be the gateways to the world’s largest payment systems; and continue to process the credit requirements of most corporate and consumers, some things have changed. Firstly, the global financial crisis had an extremely negative impact on the trust element that the banks carried, even in the current context in India we are seeing credibility of state run banks being questioned for the kind of loans given out and the losses it’s causing. It’s ultimately the tax payers money that gets put back in the system to recapitalize these behemoths and consumers have started asking why my money? Secondly, the ubiquity of mobile devices and consumer internet has begun to undercut the advantages of physical distribution that banks previously enjoyed, suddenly having thousands of branches spread across the country is no longer being seen as a huge differentiator, and going to physical branches for products is being seen as a chore. Thirdly, there has been a massive increase in the availability of widely accessible globally transparent data supplemented by the enormous digital footprints that we as consumers are leaving on the internet, this is especially significant if you couple it with a substantial decrease in the cost of computing power. Fourthly, and specially in context of India, the change in the demographics of the country, the consumers are younger, living in a “Uberised” world of instant gratification, and wanting to discover products and services sitting in the comfort of their homes rather than discovering them elsewhere and no longer wanting to wait for weeks for lending solutions which they see less as a favour from banks and more as a right.
With the above parameters in play, alternative lending can be potentially a game changer for consumers and a scary thought for traditional lenders. They promise to give instant solutions to the problem of credit, cut down on mundane paperwork, be transparent in their offerings and are willing to give consumers a superlative customer experience, a significant upgrade from what is available from banks. There are multitudes of companies in this space creating proprietary algorithms which can potentially look at consumers differently, beyond just a three digit credit score trying to bring innovative ideas and products to the forefront. These alternative lending organisations are also attracting significant venture capital to potentially give them the muscle to take on some of the behemoths in this space. Alternative Lending is trying solve two major challenges with financial services, democratization and inclusion. Democratization is a critical point as even today there exists great information asymmetry leading to uninformed financial decisions and getting products pushed down to the consumers, the recommendation process by banks/financial intermediaries is skewed towards products and services which make more money for them rather than them being the best options for the customers, technology can potentially alter this completely by giving all customers completely transparent information and recommendation and put the power in the hands of the consumer. Inclusion is the other challenge in the financial services space where a large chunk of the population does not get access to financial products, technology advancements and using services like biometrics, Aadhar integrations, Jan Dhan Yojana etc of the government it can lead to a scenario where technology can help in delivery of these products to people who currently do not have access to them and create a scenario where more and more people are getting included in the credit mainstream of the country. These are really the big reasons why alternative lending could disrupt the lending landscape.
The above context is mainly arguing why alternative lending is important and here to stay, however let me now try to highlight the challenges around this space and what needs to be overcome to really make this sector significant. The first major challenge that i see, is that too many of these start-ups( companies) are looking at solving only the credit underwriting problem using algorithms, machine learning and big data solutions, given that its critical to the lending piece, it’s not the be all and end all to the industry. What is unfortunately lacking is focus and understanding of all the pillars of the lending play, lending is as much about distribution, great products, strong brands, excellent sales and service staff, benchmarks around customer service and in collections( in the unforeseen event of the loan going delinquent) as its about credit underwriting. Too many people are making noise about credit underwriting, too little being said and most importantly done about the other pillars. One needs to keep in mind, that all of these pillars have to stand together if this industry has to thrive. The second challenge is the profile of the entrepreneur, there are too many technology enthusiasts looking at this as a technology play and too few business guys with strong banking and lending expertise who understand all facets of this space. Lending is one industry, where i feel experience is as important as a blue sky vision, credit typically goes in cycles, every 5-7 years, there is a phase of incremental credit growth, then comes the phase of high customer leverages, and then potentially losses on the books. Its people who have seen cycles in the past who can probably relate to this better, and ensure that the nuts and bolts are in place and tightened. Thirdly is the point of sky rocketing and often insane valuations of these companies, most of these start-ups want to be seen a technology companies and get valuation multiples of the same, cause they are higher and being a technology company is fancier. However the problem at hand here is not a technology problem, it’s a lending problem and while technology can enable faster and better decision making and a superior experience it cannot change the basics of what we are discussing here, and valuations of lending institutions and banks are seen differently to technology companies and substantially lower, in this context different incentives are at play which can be potentially dangerous to this space. Lastly, i want to discuss the point of regulations, banks being traditional institutions are heavily regulated, operationally and strategically, this is extremely critical as it leads to these institutions being very stable but at times also takes away from them the ability to innovate and the nimbleness to adapt. Fintech companies projecting their technological angle are mostly outside the regulations, however this scenario will change and change very quickly as these companies become bigger and more active. This brings us to a more fundamental point, are these companies ready to work in a box of regulations, and how well do the regulators understand these companies and what’s the real risk here being talked about. As the latest paper on P2P guidelines by the RBI has proven, there is more grey here than black and white and the way the regulatory play pans out may actually be the defining moment for these companies and specially in the aftermath of latest reports around leading alternate lenders globally coming under scrutiny from all sides, things can change really quickly.
At the end, one can only hope as an optimist that the alternate lending industry is quickly able to imbibe what’s good about traditional banking players, couple that with the advantages that they naturally possess, see value in working with the existing ecosystem to further improve and enhance the same and most importantly understand that great institutions are not built overnight and with great underwriting models but by taking into account everything that’s important including the people who will roll up their sleeves to work on and run these organisations in the future, and not get caught up only by the cosmetic, so called fancy aspects of disruption which they enjoy talking about, as sometimes you run the biggest danger of actually starting to believe everything you say whether you mean it or not and the fintech’s with media backing them sure seem to be saying a lot.
The author is the co-founder of Finance Buddha, a Fintech start-up, which is into retail lending products.
About the Author: Parth Pande is the co-founder of Finance Buddha
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