How Will Traditional Finance Providers Innovate in Face of Disruption?

By Henry Thomas on Friday 26 June 2015

Alternative Lending

As bank bosses in Canada complain about the advantages available to alternative finance start-ups, we take a look at how the traditional banking sector across North America is reacting to this young and innovative alternative.

The relative lack of regulation in the alternative finance space has led to CEOs in some of Canada’s banks to complain at the unfair competitive advantage this gives them - they face lower compliance costs and can access less credit worthy investors. The traditional banks of course have their own competitive advantages (a loyal customer base, large pools of capital, etc.). Their complaints could be born of the fear that disruptive finance is encroaching on their space and their profits. Some banks, however, appear less wary and are keen to embrace this revolution.

Victor Dodig, the CEO of CIBC, says that they “can play in that space” too and claims that reports that new startups will take significant market share are exaggerated. Consumers will be happy to hear that he points out that the increased competition may drive bank fees down: “will there be pressure over time? Of course there will be.” Dodig emphasises the importance of the competitive advantage held by the traditional banks, particularly the significance of trust and track record, saying that:

Clients that have money with an institution want to make sure that it’s stable and secure because insurance only gives you protection to a certain level.”

CIBC has a history of innovation: it was the first Canadian bank to offer ATMs in 1969 and the first to offer telephone and online banking. Now their CEO has announced that they are looking into blockchain technology. Dodig expressed that at this early stage they were investigating the extent of security behind the technology.

Over the border, there is more evidence of traditional banks innovating. The entrance of Goldman Sachs into Marketplace lending has been well reported by AltFi – where, according to CEO Blankfein and Executive Director Cohn: “unlike the LendingClub marketplace model, Goldman will make loans directly.” This move will be a great example of an established bank utilising an internet based platform. Blankfein and Cohn go on to say:

It’s also a way for Goldman to expand its banking business without going to the trouble of opening up actual branches.”

This allows them to cut costs and eliminate one the competitive edges of alternative platforms. Anil Stocker (Chief executive and co-founder of start-up MarketInVoice) noted, however, that “having the idea to launch an online lending product is not innovative”. The real innovation is still to come, he continued:

The important bit is the delivery of cheaper, more transparent, more flexible products with a great user experience. It will be interesting to see if Goldman Sachs can deliver these results as well as non-bank providers of online finance."

Perhaps the boldest show of innovation has come from the US’s community banks – and the creation of BancAlliance. In an effort to compete with larger national financial institutions, a consortium of smaller banks, typically ranging from $200M to $10B in assets, have teamed up with LendingClub to enhance their consumer loan department. Renaud Laplanche (CEO of Lending Club) says that:

While there's always room for healthy competition, the largest opportunity is for marketplaces and banks to collaborate

The community banks, which previously struggled to compete with the national firms – as their smaller capital pool restricted the consumer base that they could serve – now make use of LendingClub’s loan analysis and open themselves up to a larger pool of borrowers. The use of LendingClub also lowers the costs for the traditional branch-based community banks and these two facts together allows the community banks to make credit more affordable for consumers and also allows them to compete with the national financial institutions. Sandra Pattie (BankNewport’s CEO) told WSJ: “We have to make sure we remain relevant”. Whilst there are significant risks in sharing their customer lists with another firm, community banks have been forced to innovate, having seen their consumer loans market share fall from 75% to 9% over the last 25 years.

This partnership may provide LendingClub with some of the tools that Dodig cited as traditional banks’ competitive edge: trust and track record. If further cooperation between smaller traditional banks and online platforms happens then more large financial institutions may be forced to enter the alternative space in a more pronounced way. Interestingly, Goldman Sachs’ venture makes use of their competitive edge: an enormous pool of capital, as borrowers will borrow directly from Goldman and not on a peer-to-peer basis.

As the alternative sector continues to grow and to threaten to impinge upon the revenues of traditional banks, it shall be interesting to see whether the two forces combine or compete. The community banks and Lending Club/ Prosper have gone for the first option, whilst Goldman appears to be selecting the latter. Only time will tell how their competitors respond.

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