While keeping calm about crowdsourcing’s exponential growth, banks are investigating ways to collaborate with the coolest kids on the finance block. Melodie Michel outlines the options available to them.
“Alternative” is a word that non-bank lenders are trying to phase out – after all, some of the most established ones have been funding businesses for decades, and are an integral part of some corporates’ financing mix. But one newcomer to the non-bank scene is making particularly strong waves: crowdsourcing, which includes crowdfunding and peer-to-peer lending, has outpaced all growth predictions, and left banks, previously dismissive of what represents only a tiny market share, wondering what strategy to adopt towards the new player.
While the definitions around crowdfunding and peer-to-peer (P2P) lending are not always clear, the lenders’ exponential growth is evident – in 2015, crowdfunding volume is expected to reach US$34.4bn, while P2P loan volume could reach US$77bn. What’s even more impressive is the pace at which the sector is growing: just six years ago in 2009, crowdfunding delivered financing worth only US$530mn.
Compared to the size of the banking market, this is still very marginal, but a sector that more than doubles in size every year is deserving of the financial world’s attention for many reasons. First, it is symptomatic of both structural and communicational issues that could be addressed, at least partially, within the banking system.
Asked whether they used the alternative finance market as a back-up or first option for their financing needs during a panel at GTR’s UK Trade and Export Finance Conference in June, two out of three SMEs said they would approach their bank last. “We’re not having an intelligent conversation about the business. It’s not relevant, it’s too long, too cumbersome. There are alternatives out there that are much faster, listening to us, vetting us – [the alternative finance] business is serious so why would we go to the bank? It can be more expensive but I just see the bank as a dead end,” said Geraldine Grandidier, founder of Tidy Books.
Of the other SME owners which, like Grandidier, have used crowdfunding platforms, some said they did not have a personal relationship with their bank manager, but rather spoke to a different person every time they made contact – which impaired the possibility of building trust between the two parties.
While banks’ heavy regulations make their processes long and cumbersome, P2P and crowdfunding lenders can respond swiftly to funding requests and disburse loans within weeks – sometimes even days. And though they initially operated mainly in the start-up equity space, these lenders are diversifying more and more: according to research firm massolutions, lending-based crowdfunding grew 223% in 2014, to US$11.08bn (US$1.1bn for equity-based crowdfunding). Similarly, P2P lenders involved in receivables finance are increasingly looking at the whole cycle, from purchase order through to manufacturing and invoicing – a holistic approach that used to be the banks’ differentiator.
Level regulatory playing field?
Of course there is the ongoing debate around how regulated these entities are, but it would appear to be fuelled mainly by banks wanting to level out the competitive playing field.
“It has been argued by some commentators that alternative lenders should all be regulated by a central authority and apply for a banking licence, secure their short and long-term credit ratings, undergo the same regulatory reporting and scrutiny against sanctions as banks and apply the same compliance and Know-Your-Customer criteria,” Mauro Bonacina, Emea sales officer, treasury services at BNY Mellon, tells GTR.
Yet in an audience poll at GTR’s UK event, the majority (46%) of respondents said they didn’t believe the sector should be regulated in the same way as banks – a result that delighted Angus Dent, chief executive of P2P platform Archover. “We are and want to be regulated, but it is an alternative function, it isn’t the same and it wouldn’t be appropriate to have the same level of regulation,” he said. The argument here is that crowdsourcing investors know where their money is going and willingly accept the risks associated with transactions, as opposed to depositors within banks.
So if banks can’t compete with crowdsourcing firms on a level playing field, how else can they interact? Bonacina suggests the possibility of banks acquiring crowdfunding platforms in a not-so-distant future. “There is room for co-operation, or what I’d refer to as ‘co-opetition’. Of course we are referring to eligible and qualified counterparties, with sound financials, a good reputation and a proven track record.
“Banks might see a business opportunity by buying a crowdfunding platform. This could be attractive for institutions with a focus on innovation, growth and back-office solutions. It presents no credit risk and offers pure processing with a return of at least 250 basis points,” he says.
But others are sceptical: “With a few exceptions the technology is not that sophisticated, nothing that couldn’t be replicated so [banks] wouldn’t be paying £100,000 or more for it,” says Geoffrey de Mowbray, managing director of SME Dints International.
Even if they did spend the money, how would banks’ acquisition of these platforms impact their processes, from a regulatory standpoint? “As soon as the banks get hold of an independent, flexible, creative entrepreneurial business, they will regulate it within an inch of its life and it will look like the rest of the banks, so that’s probably not the answer,” believes John Bugeja, managing director of consultancy Trade Advisory Network (and a former banker).
Even Bonacina concedes that the platforms’ flexibility could be altered by regulators in the case of an acquisition.
Using platforms for distribution
Another way these two very different lenders could collaborate is if banks used the platforms to distribute funds. “What the alternative lenders have got their heads around is how to deploy the money effectively. “If you match that with the cost of finance that comes out of the banks, you’re onto a winner,” says de Mowbray.
Government-backed financial institutions have already started to invest through P2P lenders – such as the British Business Bank, which has lent a total of £60mn via Funding Circle – and commercial banks could soon follow. “That probably has already happened without being announced. I’m sure it will happen and be announced very soon. The banks have a low cost of capital, and it’s good business for them to lend over our platforms,” Dent at Archover explains.
There could also be some sort of matching programme between banks and these platforms, whereby for each dollar raised through crowdfunding, the banks would lend another dollar – another idea that has yet to be observed in the market. But wouldn’t collaboration between banks and crowdsourcing platforms taint the perceived cultural bond between SMEs and these alternative lenders, most of them also SMEs? Not according to Bonacina. “In most cases the choice is basically driven by the availability of credit and the economic conditions which govern the contract. All things being equal, borrowers could surely opt for the lender they feel closer to and who understands their needs the best. But (…) things are not equal yet,” he says.
And judging by de Mowbray’s experience, it seems like he is right: Dints’ MD started his business with crowdfunding, then moved onto technology-based financiers and is now looking into bank finance. “My opinion is changing. We’ve never actually used bank finance but our focus is shifting now towards the banks. We built our business with crowdfunding, but it’s not the cheapest finance out there, and there are some restrictions using alternative financing. I personally believe there’s a space for it all but selling in double or triple-digit million contracts, alternative financing is not always cost-effective. I do think banks sourcing sales through those platforms would probably make the most sense,” he points out.
It seems inevitable that, sooner or later, banks and crowdsourcing platforms will do business together – how they choose to collaborate is the question that remains to be answered. But for now, the two players are keeping their distances, taking their time
to carefully ponder their respective strategies.