Since the 2008 crisis, we have seen a very exciting evolution in the lending landscape. It is replete with a variety of new business models and a very different regulatory framework.
We live in a world that will most probably be documented in history books as the fourth major industrial revolution. In the last decade, new technologies have emerged that enabled increased connectivity and digital computing power, which have significantly impacted the way business is done. Airbnb became the largest hotel business without owning any hotels. Upwork became a large HR agency without having any people on their payroll. Ant Financial became a financial services company in record time with over 500 million users based on the trust gained on the Alibaba platform.
The list of new business models in the financial industry is extensive. There are over 4000 disruptive Fintech startups. Some have already obtained banking licenses while others operate outside the regulatory framework. Many new businesses are built adjacent to existing ones (Amazon, Alipay) or financed by venture funds of incumbent players.
Business models are no longer based on narrow definitions. Players are moving across industries and segments successfully and competitors arise from companies outside traditional boundaries.
There are several examples of industry players moving from
·Payments to Lending (PayPal)
·Ecommerce to Lending (Amazon)
·AliPay/Ant Financials or MyBank (by Alibaba)
·Social Media to Payments (Facebook)
·Sharing economy to Financing (Airbnb)
·Telecommunication companies into Financial Services (Vodafone Wallet, Softcard).
According to a McKinsey survey, one-third of TelCos are considering moving into financial services. Ant Financial, riding on the Alibaba E-commerce success, has over 500 million annual active users and the ambition to grow to over 2 billion users within 10 years — without owning significant assets. As of March 2017, PayPal has grown to a market cap of USD 52 billion, which is higher than the market cap of many major European banks (Soc Gen, Credit Suisse, RBS, Deutsche) but with a balance sheet less than 5% than any of these players.
This begs the question about what it now takes to become a successful financial services provider: Can a company provide lending services without owning any financial assets or having long-standing consumer relationships?
There are three distinctive key success factors in the financial services industry: Trust, Ability to Price Risk and Efficiency. These categories remained quite the same for decades, but the interpretations are clearly changing.
I.Trust: Can the company build trust among consumers?
Trust is the most important factor in financial services. The crisis left a painfully low confidence level for existing players and it is still an industry where trust is fragile. Even though the Edelman Trust Barometer survey showed that people’s trust in financial services improved by 8% (from 43% to 51%) from 2012-2016, it still remains one of the least trusted industries which might have to do with the number of scandals that happened in the industry in the lasts 10 years.
Trust is hard to build, it takes seconds to break and it takes very long to rebuild. This is demonstrated by many examples in the past and it is not any different today (eg. Lending Club).
The regulatory framework can still play an important role in giving accreditation, though it is fair to say that many customers became disappointed and lost faith in rating agencies and the ability of regulators to prevent a crisis.
How is trust being re-interpreted?
Trust has quite a different meaning today than a decade ago. The Edelman survey confirms that data, safety and social responsibility are critical in building trust in financial services. Many incumbent players have made it their mission to improve these social aspects, including financial education.
New Fintech players are applying many other features broadly. For example, Alipay solved the trust barrier via escrow payment. The introduction of SSL technology, seller and buyer protection policy as well as the easy application have contributed to PayPal’s success.
How these players achieved Trust?
Technology companies (Google, Amazon) are among the most trusted in the world and this perceived trustworthiness might put them a strong position to launch products in the financial services. Generational changes are also driving the interpretation of trust. The younger generation increasingly prefers online solutions over in-person interactions when it comes to investing and banking. A recent survey from Accenture suggests that one in three global customers would switch their accounts to Google, Amazon or Facebook if they could.A similar survey 2 years ago suggested only 20%.
II.Risk Pricing:Does the financial services company have the risk models, capacity, sourcing potential, and wherewithal to gather relevant and credible information to price the risks appropriately?
The ability to price risk remains an essential factor, especially in the lending business. By using alternative data, there are extended possibilities to develop enhanced risk scoring systems. Access to data and using technology does empower players to price and manage risk. In the world of big data concentrated on a few players, information is a huge advantage.
Some companies have better access to data than incumbent banks to assess and price risk.
For example:
·Airbnb might have better ability to price “buy to let” mortgages due to a broad range of information on rentability, supply and demand of properties in different regions.
·Zalando might have better information to assess financing certain products of suppliers (in supply chain or working capital financing).
·Alibaba, and consequently AliPay, has integrated information on consumers’ habits and history and might be the best positioned to grant consumer loans.
The list is extensive.
III.Efficiency: Can the financial services company distribute its products and services efficiently?
In financial services, efficiency and scale have been always important. It remains a capital-intensive business with high fixed costs. Adding new customers creates operational leverage and has a direct impact on the bottom line.
There are multiple circ*mstances (low-interest environment, new products with cheaper cost base, etc.) that currently creating a huge downward pressure on the cost of financial services across all ranges. Digital channels can be 60-80% cheaper than traditional bank branches and Lending and Payments services are increasingly online. Many of the new and incumbent players prefer “streamlined and simple” because using mobile does limit the marketing effectiveness of more complex products and services.
The speed of execution is likely to be more important. At the World Economic Forum held earlier this year, Alibaba founder Jack Ma described his lending philosophy in three numbers:
"3 – 1 – 0:3 minutes for credit assessment – 1 minute for payment transfer – zero human interaction" (Jack Ma)
Many of the new platforms are being created from scratch and therefore, they come without any operational legacy. They might be more efficient in keeping up with the shifting consumer needs, which is expected to create strong competition to retain customers.
Conclusion
For decades, the financial services industry has relied on three key success factors: Trust, Risk Pricing and Efficiency. Interpreting these factors Anno 2017, I recognize that some players outside the existing traditional ecosystem might be better positioned to gain competitive advantage and capture a wider market share.
While there are approximately 15,000 banks worldwide today, this number is likely to be reduced dramatically. Those who gain trust and master the technology with seamless execution from the consumer’s perspective are the most likely succeed.
The key question remains who will be those winners....?
