Regulation and Fintech Will Fuel the Resurgence of Alternative Lending

Howard Goldstein  |

When UK-based lender Zopa first launched its peer-to-peer (P2P) lending platform back in 2005, many within the traditional banking industry were skeptical. And even when LendingClub  (LC) and a handful of other P2P lenders launched the next year, businesses still went to banks for loans and working capital, despite the slow, often restrictive financing requirements by the latter.

But with the financial crisis of 2007-2008, bank lending to small businesses fell by 18 percent, throwing alternative lending into the limelight as small businesses sought capital to keep their operations running. The following years saw alternative lending grow massively – LendingClub went on to become the first publicly listed alternative lender on the NYSE by the end of 2014 and three alternative lenders, Kabbage, SoFi, and Avant had raked in a whopping $6.3 billion in funding from investors.

Between 2014 and 2017, however, the industry’s growth slowed down significantly, thanks to crackdowns, acquisitions, and mergers within the industry. These events, coupled with an improving American economy, had slowly seen the traditional banking sector recoup some of the mileage it had lost to alternative lenders in years past.

As we head deeper into 2019 and beyond, there’s every indication that the alternative lending industry will continue on its path of growth. Here are two trends that are likely to fuel this resurgence.

Improved Regulation

For the most part, the alternative lending industry had remained unregulated, with many providers building their business models around hefty fees that often hurt small businesses. According to LoanStar, an online lending aggregator, some payday loans easily exceed 300 percent annual interest and are often offered to cash-strapped businesses with a high default probability.

And unlike banks and other traditional lenders, alternative lenders often freeze declared assets a few days after the missed payment.

As such, many countries have been introducing new regulations to cover the industry, which should help cushion businesses against unfair practices. In the US, for instance, the Consumer Financial Protection Bureau (CFPB) introduced new rules in 2017 requiring payday lenders to ascertain the ability of their clients to repay before dishing out loans, a measure that is helping to grow existing lending companies while protecting the consumer.

In China, the government began regulating the country’s massive alternative lending industry in 2015 via the China Banking Regulatory Commission (CBRC). With a transaction volume of over $222 billion, the country has the highest value of alternative loans in the world, thus making China a prime location for unscrupulous lenders. The CBRC required, among other things, that businesses procure an operating license, pegged interest rates at 36 percent annualized, and illegalized loans to consumers without an income.

Other countries such as the UK have created innovation-friendly guidelines within the fintech sector, with authorities such as the British Business Bank (BBB) and the Financial Conduct Authority (FCA) charged with regulating the alternative lending industry.

Developments in Fintech

Part of the reason why regulations have become necessary is the rate at which new technology is transforming the industry. Tech trends such as machine learning, blockchain-powered smart contracts, and mobile payments have transformed the way alternative lenders acquire customers, process and disburse loans, and any future developments will only serve to grow the industry.

One of the biggest effects of fintech has been convergence, a trend that has seen more banks working together with alternative lenders to produce innovative products and services, something that was unheard of a few years ago.

Alternative lenders are among entities in the finance industry with a high uptake of technology, which is often used to speed up lending decisions and reduce risk. By combining this appetite for new technology with the huge databases of proprietary customer data from banks, these conservative banks and alternative lenders are forming a strong union, which is helping create a new breed of lenders with more attractive rates and faster processing times compared to traditional alternative lenders and standalone banks.

In addition to the customer databases from banks, alternative lenders are benefiting greatly from new data points for use in underwriting. Data sets from ecommerce platforms are being used to determine the creditworthiness of potential customers, with information such as the value of inventory and revenue estimates being used to make lending decisions by alternative lenders. Amazon  (AMZN), for instance, shares income information with some state governments in the US, with Ant Financial, an affiliate of Alibaba Group  (BABA), using customer data to track behavioral patterns and customer relationships to influence lending decisions.

In conclusion, the current environment within the financial industry is prime for alternative lenders to thrive. With a thriving global economy, more banks working with alternative lenders and more regulation helping to prune out unfair providers within the industry, we can expect a thriving alternative lending industry over the next couple of years.

DISCLOSURE: I hold no positions nor receive any compensation from any of the companies mentioned in this article.


The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
BABA Alibaba Group Holding Limited American Depositary Shares each representing one 172.99 0.19 0.11 13,646,504 Trade
LC LendingClub Corporation 15.23 -0.45 -2.87 894,976 Trade
AMZN Amazon.com Inc. 1,964.52 -13.38 -0.68 3,182,990 Trade

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