The Potential Hazards of Alternative Lending for Banks

While the consumer market is excited about the opportunities brought into their lives by FinTech, banks have been furiously trying to figure out how to ride the upcoming wave of major changes the industry will go through. Some can leverage the trend and new opportunities; others, however, are paralyzed with the hazards it brings to traditional players.

The complexity of relationships between traditional players and startups has led to a massive debate and a crack in the foundation of previously established by banks principles. Financial institutions that are able to adapt and accept the reality hand in hand with innovative players will certainly be able to find a place for their plastic cards in consumers’ wallets. Nonetheless, before that happens, there are certain negative processes that banks will go through as seen by organizations like WEF and others.

Traditional deposits and investment products will be struck by alternative lending platforms as consumers will see more benefits from short- and medium-term investments rather than what they will be able to receive from banks. Higher interest rates on investments made on alternative lending platforms will make a bank deposit redundant and cut available resources for banks.

As a result of that process, financial institutions' balance sheets would raise questions regarding the ability of the bank to meet lending requirements. As regulatory bodies impose capital requirements to ensure sustainability of big banks, eroded deposits will lead to a reduced lending ability.

It should not come as a surprise anymore that in 2016, there is a wide array of FinTech companies that can potentially substitute almost any bank service. Aside from a threat to similar bank services, it leads to a significant diversification of consumers’ funds across companies/accounts/geographies, etc. Hence, banks are struggling in accurate measurement of the creditworthiness of a particular customer that has his funds across a range of platforms with inconsistent standards. In that case, the FICO score almost completely loses its accuracy and relevance if it can’t capture and measure the financial activities of a customer using alternative lending platforms.

Needless to say, increased competition to every bank department will pressure the margins and the spread earned from interests paid on deposits and the interest earned from borrowers. Digital transformation doesn’t come in handy either. Traditional players burdened with capital requirements, a massive network of physical branches and maintenance costs left little to no chance to fight lightweight platforms with no need to maintain legacy systems. Regulatory bodies and licensing costs don’t particularly help banks either.

Customer experience is another landmine (in addition to digitization) placed by alternative lenders. If a customer can ensure a loan on the platform in five minutes, it makes paperwork and multiple branch visits redundant. Lower foot traffic, fewer loan originations, lower return from the branch—all are a hint for the bank to shut down and cut employees loose. We can already observe the trend with the growing popularity of challenger banks and the example of Bank of America. Speaking of the shutdown of bank branches, even though it is a side effect of alternative lenders’ damage to banks, it has a negative outcome for a small business community. On one hand, alternative lenders focused on business loans create opportunities for entrepreneurs and on the other, they facilitate the financial desert phenomenon in small communities.