Fintech is not disruptive, as banks adapt and thrive

I’ve written a lot about banking not being disrupted by Fintech, no matter how much the upstarts claim.  A few articles of note:

How a bank should respond to 'disruption' (August 2009)

Is banking being fundamentally disrupted by technology change? (September 2013)

We are not being disrupted, just rearchitected (October 2014)

Banks are too regulated to be disrupted (April 2015)

Social lending is not so social (September 2015)

In fact, the more I think about things the more I realise that most fintech is supplementing the bank industry rather than disintermediating, disrupting or displacing it.  P2P is just acting as the credit risk department of financial institutions; Square is just an SME acquirer on behalf of card companies; bitcoin has become bankcoin as the blockchain is incorporated by institutions; and nothing is really changing the core of the bank system.

Last Friday’s Financial Times seems to agree with me:

Bank disrupters fail to live up to hype

All hail the disrupters. Agile marketplace lenders will displace the sluggish banks. Lending Club, Prosper, OnDeck, SoFi and a host of other whizzy-sounding, tech-savvy companies will use market efficiency to connect sources of capital with those who need it.

We are so far into the hype that, even before we have seen much realisation of the potential, there are bubble warnings. However, by and large, the excitement and the fears are overdone. The tell-tale sign is a traditional bank hiding in the undergrowth. And the biggest exception wants to become a bank in all but name.

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Take Simple. Billed as an anti-bank, the Oregon-based company is essentially a superior bank website. It took deposits that were held by Bancorp, a private label bank, motto: “You may not have heard a lot about us. And that’s by design.” Then Simple was sold to BBVA, the large Spanish lender, and any pretence was over.

Even less advertently, Lending Club and Prosper — “marketplace” lenders that allow investors to buy consumer loans — are not really platforms to connect the source and recipient of capital. They find potential borrowers, use another secretive bank, Utah-based WebBank, to write the loans, and then sell them on to investors. The bank is critical.

The odd one out is potentially San Francisco-based Social Finance, known as SoFi. In some ways SoFi seems the most modest of the bunch. It was founded on the insight that people who had attended top US universities were far less likely to default on student loans than those at less prestigious colleges, yet were paying the same rate. Investors were, indeed, prepared to buy debt from this cohort at cheaper than the 6.8 per cent standard rate and SoFi was in business.

But it has done something unusual — from that small group of borrowers, with a single product, student loans, it is betting on breadth. SoFi has already diversified into mortgages and personal loans and claims to be producing loans at an annual rate of $5bn.

Lending Club’s current market is much bigger — it is originating about $8bn of loans annually — but it is dependent on credit card consolidation, charging competitive but much higher rates to mass market borrowers.

Todd Baker, managing principal of Broadmoor Consulting, a critic of the marketplace model, acknowledges: “I think SoFi is rather different.” But he adds: “It doesn’t change the fundamental problem that it’s subject to the vagaries of institutional funding.”

This is true. SoFi and its peers need an active market of investors, and credit lines. If it starts to see a rash of defaults, investor returns will worsen and its market will dry up. It is still hard to see that scenario being disastrous for the financial system, however. Federal Reserve officials have been relaxed in recent years about banks losing market share to less leveraged entities. Bear in mind, also, that SoFi says it has incurred only four defaults, all through death.

More important, though, the criticism underestimates the ambition behind the project. Mike Cagney, chief executive and a former top trader at Wells Fargo, the world’s biggest bank by market capitalisation, wants a wealth management arm, wants to process credit cards and wants to take customer deposits.

This sounds a lot like traditional banking — not least the “cross sell” which Wells Fargo prides itself on — but that might make it the most disruptive and aggressive move of the lot. If SoFi can pull it off and find regulators who permit it, it would hold deposits without government insurance — private insurers might take on the risk to discourage depositors from pulling their money during an economic crisis.

It would continue to escape rules laid down by the Federal Deposit Insurance Corporation, which prevent banks from lending money at a cheaper rate in certain areas — says Stanford University — than another, poorer county. That discrimination, or segmentation, of borrowers could still cause public relations or regulatory problems.

And yet SoFi believes it can actually end up being more consumer friendly than banks, offering to freeze loans if a borrower loses his job. Such forbearance is traditionally only available in government-backed lending because banks are instructed to preserve capital at all costs.

No surprise that Peter Thiel, the PayPal co-founder, whose libertarian tendencies have previously seen him invest in plans for a self-governing sea colony, is an early investor. The latest funding round brought in SoftBank of Japan at a cool $4bn valuation. The real disrupter could be a non-bank bank.

Where’s the real change going to come from?