Issue: Fintech Fintech

Issue: Fintech Fintech By: Victoria Finkle Pub. Date: September 12, 2016 Access Date: September 26, 2021 DOI: 10.1177/237455680218.n1 Source URL: http://businessresearcher.sagepub.com/sbr-1775-100731-2748617/20160912/fintech ©2021 SAGE Publishing, Inc. All Rights Reserved. ©2021 SAGE Publishing, Inc. All Rights Reserved. Will financial technology startups disrupt traditional banking? Executive Summary The surge of financial technology startups—or “fintechs”—is improving the speed and quality of customer service of lending, money transfers, wealth management and much more in the banking industry. As these firms become more prominent in the financial services sector, banks and regulators will have to adapt. Banks already are beginning to integrate these new services by investing in or partnering with fintechs and by developing similar technologies on their own. Regulators are rushing to understand the nature of these new firms and the potential benefits and threats they pose to the financial system. As the financial sector debates the future of fintech, here are some of the issues under consideration: Will fintech replace traditional banking? Are alternative lenders reshaping how people borrow? Is government capable of regulating the emerging fintech industry? Overview Lending Club’s banner hangs on the New York Stock Exchange façade for its IPO in December 2014. The alternative lender embodies both the promise and perils of fintech. (Don Emmert/AFP/Getty Images) James Song realized he needed access to some fast cash. A lot of it. It was 2007, and Song was building the first plastic recycling plant in Uganda, where he had traveled on a Fulbright scholarship after graduating from Harvard University two years earlier. His goal was to reduce the spread of malaria, a mosquito-borne virus. Plastic bags littered Uganda’s streets and blocked sewers, creating pools of standing water that are a breeding grounds for the pests. The only problem? Song was out of money. He had started building the plant with money he had raised from friends and family, but he needed $25,000 to finish the project. The most obvious solution, turning to a bank, seemed like a long shot. “I was absolutely not optimistic about getting a bank loan,” says Song, who now runs Faircap Partners, an investment management firm focused on development in Myanmar. Not to mention, he was running out of time before the machinery he ordered would arrive. Dejected, Song was surfing the internet at a café in Uganda when he came across an intriguing opportunity. A new company called Lending Club was offering fast loans of up to $25,000. Song says requesting a loan through the fledgling site was a “no-brainer,” given his Page 2 of 24 Fintech SAGE Business Researcher ©2021 SAGE Publishing, Inc. All Rights Reserved. situation. To his surprise, Song’s loan was funded in a matter of days, at an annual rate of just over 11 percent. He paid off the loan in three years without missing a monthly payment. “It saved the business, and I ended up creating the recycling infrastructure in Uganda over the next few years,” Song says. At the time, Lending Club offered what’s known as peer-to-peer loans, in which individuals posted loan requests and others funded them directly. Song notes that a single person funded almost half his loan. The site then operated solely as a Facebook app, though its reach quickly spread. Lending Club said it facilitated half a million dollars’ worth of loans within two months of opening for business in 2007. 1 Today, Lending Club is one of the biggest players in the alternative lender community, having originated more than $20 billion in loans since its launch. Borrowers most commonly use the loans to pay off or refinance existing credit card debt, while others tap the funds to pay for major one-off expenses like a wedding, business expansion, medical treatment or home improvement project. 2 Wall Street players, including hedge funds, asset managers and big banks, make up a growing share of the company’s lending base. 3 But the same company that provided a vital financial lifeline to Song and other borrowers has faced its own riptides. Recent allegations surrounding the firm’s faulty internal controls and the questionable actions of founder and former CEO Renaud Laplanche have shaken the company, and also served to illustrate the perils that accompany the promise of “fintech,” the hottest trend in banking right now. The rapid expansion of tech-driven financial startups has positioned them to challenge the supremacy of traditional banks; this quick growth has also saddled the newcomers with growing pains and some doubts about their long-term viability. At the same time, the fintech boom is compelling the established banking industry to think about how it too can harness technology to better serve its customers through ongoing investments in new products and partnerships with startups. Fintech is an umbrella term that describes a wide range of new digital services that are transforming the banking industry. They include online loans, crowdfunding platforms such as Kickstarter, digital currencies such as bitcoin, algorithm-based wealth management firms such as Betterment and mobile payment companies such as PayPal and Square. Fintech also encompasses new online remittance services for sending money internationally, personal budgeting software such as Mint and digital wallets such as Apple Pay. “You’re dealing with money and a computer—now, almost everything could fall under the definition of fintech,” says Edward Mills, a policy analyst at FBR Capital Markets, an investment banking and advisory firm based in Arlington, Va. Investment in fintech companies has exploded in recent years, with more than $50 billion in financing going to more than 2,500 fintech firms around the world since 2010. 4 Global investment grew 75 percent to more than $22 billion in 2015 alone. 5 Separately, Goldman Sachs estimates that the total amount of revenue at stake in the competition between the traditional banking industry and fintech companies involved in crowdfunding, payments, wealth management and lending is $4.7 trillion. 6 A host of factors has shaped fintech’s rise. For example, stricter rules for banks after the 2007-09 financial crisis created an opening for nimbler upstarts, while the spread of mobile phones and digital access has changed how consumers can run their financial lives. Younger and wealthier consumers seeking quicker access to a wide variety of financial services are driving the trend. 7 Page 3 of 24 Fintech SAGE Business Researcher ©2021 SAGE Publishing, Inc. All Rights Reserved. A sign in a Berlin pub reflects the growing interest in the digital currency bitcoin and other “cryptocurrencies.” (Sean Gallup/Getty Images) “The fintech providers are carving out a position in the market as being the fastest, most responsive players,” says Ron Shevlin, director of research at Cornerstone Advisors, a financial consulting firm in Scottsdale, Ariz. “For a growing percentage of younger consumers, it’s more about speed and how easy is the experience. And that’s a growing threat that I don’t think a lot of banks really appreciate today.” How big a threat this will ultimately pose for traditional banks, large and small, remains to be seen. In some cases, such as with the use of digital currencies like bitcoin, widespread adoption could one day be revolutionary for traditional banks, regulators and fintechs alike. Central banks around the world already are exploring potential uses of the technology, which removes the “middleman” from financial transactions. 8 “It does this by taking the all-important role of the ledger-keeping away from centralized financial institutions and handing it to a network of autonomous computers, creating a decentralized system of trust that operates outside the control of any one institution,” wrote Wall Street Journal reporters Paul Vigna and Michael J. Casey in their book The Age of Cryptocurrency. 9 “At their core, cryptocurrencies are built around the principle of a universal, inviolable ledger, one that is made fully public and is constantly being verified by these high-powered computers, each essentially acting independently of the others.” In other cases, such as in the online wealth management space, major brokerage players like Charles Schwab are scrambling to compete with the startups. Firms including Betterment and Wealthfront are now managing billions of dollars in assets of consumers who can’t afford or don’t need a personal wealth adviser, but can benefit from the new algorithm-based investing services, also called robo-advisers. 10 Meanwhile, online money transfer companies like PayPal and Venmo (which is owned by PayPal) are making it easier for customers to make purchases online and share money with each other. But the fintech industry is facing its own challenges and competitive pressures. Laplanche, Lending Club’s founder and a pioneer in the industry, stepped down as CEO in May 2016 after an internal investigation found that several loans had been mishandled and that Laplanche had encouraged the firm to invest in another company without disclosing his own stake in it. 11 A month later, the company announced that Laplanche and some of his family members took out loans in the company’s early days to help give the appearance of growth and that the firm had improperly valued some internal private investment funds. 12 On top of that, Lending Club, along with rivals including Prosper and Avant, announced significant layoffs over the summer, raising questions about the viability of the online lending business if the economy were to dip into another recession. 13 The industry’s troubles Page 4 of 24 Fintech SAGE Business Researcher ©2021 SAGE Publishing, Inc. All Rights Reserved. may be starting to spook hedge funds and other institutional investors that have been backing the alternative lenders, which could force the companies to seek capital elsewhere.

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