Fintech consumer lending has more than doubled in just four years, growing from a 22.4% share of personal loan originations in March of 2015 to 49.4% of that market in March of 2019, according to Experian.
How have they done it? They’ve leveraged the latest tech and data analytics to make their products faster, more efficient, and easier to access. Loans that would’ve taken weeks or months, and an inch-thick stack of paperwork, if a consumer had gone through a traditional lender, can now take less than an hour on a smartphone.
This won’t be just a flash in the pan, either, judging by the demographic mix of borrowers. While traditional lenders service a much larger segment of the Baby Boomer population, fintech lenders service much larger segments of Generations X, Y, and Z.
Much the same has happened in the small-business lending market where fintech lenders grew rapidly to fill a void left as large traditional lenders pulled back in the years following the financial crisis. Traditional lenders came back, but the fintechs have remained and grown.
But it’s not all gloom and doom. Consumers and small businesses are learning that there’s a price to pay for all that speed and convenience, which leaves ample opening for traditional lenders to not just hold their own in the new marketplace, but even to push back.
Midsize and community banks have several distinct advantages over fintech lenders, but let’s not ignore the obvious: Fintech lenders have brought a lot of radical innovation to the table. The best way for traditional banks and credit unions to compete with them is a two-pronged approach of one, leveraging their advantages, and two, matching their innovations.
First let’s take a look at four advantages that traditional lenders have over fintech companies.
Advantage 1: Lower Rates And Greater Flexibility
The first advantage applies primarily to small business loans where the competition comes from B2B lenders including Affirm, LendKey, Kabbage, Funding Circle and many others.
One of the biggest disadvantages of B2B fintech lenders is that they charge much higher interest rates than traditional banks. Look, for example, at one of the most common bank loans — the SBA (7)(a) small business loan. These loans are 85% guaranteed by the Small Business Administration (SBA) meaning banks are able to offer these loans at very reasonable interest rates. Fintech lenders don’t have access to this guarantee, and their equivalent loans come with much higher rates.
And for all the convenience touted by fintech lenders, this loan is one of many examples where traditional banks actually have the edge in convenience. Not only can banks extend these loans over generous 10-year terms, they also offer features like projection-based underwriting, in which loans are based on the projected future profits of the business venture. For all their data analysis, fintech lenders don’t offer small business loans like this.
The smaller fintech lenders also can’t often offer real estate investment loans to those who need them when using investment vehicles like the 1031 Exchange, or bridge and blanket mortgage loans, FHA loans, 203k loans, and more.
Advantage 2: Greater Security
Fintech lenders, as noted, have seen explosive growth over the past few years. But experts point out that personal loan accounts are the first to go into default when the economy enters a down cycle. That means that in the next recession, fintech lenders may be the first ones to feel the pain. A large proportion of their customers only come to them after being turned down by a traditional bank.
None of this can be reassuring to borrowers. Particularly for mortgage loans, which represent not only a borrower’s financial future, but the literal roof over their head. No one wants to entrust their home loan to a year-old company that might not exist in another year. Traditional banks specialize in prime loans, and in most cases have weathered many economic cycles. And while banks and credit unions are not immune to financial trouble, they are examined regularly. It’s an advantage that traditional institutions can use to greater effect.
Advantage 3: Larger Loan Amounts
Another advantage of many traditional lenders over fintech lenders is, well, having more money. LendingClub, one of the most successful alternative lenders, has a market cap of just over $1.1 billion. Wells Fargo, on the other hand, has a $280 billion market cap. That comparison makes the point, but even much smaller financial institutions typically can lend more than most fintechs.
” The average loan from a fintech lender is only $5,548, according to Experian. That’s the very definition of small potatoes.”
— Ben Mizes, Clever Real Estate
The average loan from a fintech lender is only $5,548, according to Experian. That’s the very definition of small potatoes. The fact is, most of these startup lenders just don’t have the capital to extend anything but modest loans, especially when you consider that most of them rely on investors, not deposits, for funding unless they have a partnership with one or more financial institutions.
Borrowers in need of sizable cash injections will continue to go to traditional banks. Even in this era of disruption, it’s wise to keep a proper sense of proportion.
Advantage 4: A Real, and Broad, Relationship
One of the keys to the success of online banks and fintech lenders is that they’ve “unbundled” financial services. This means they’ve targeted specific bank functions, and aimed to offer them cheaper and faster than a traditional bank would.
But while this has led them to quick success in some of niches, no fintech company is able to offer the breadth of services, much less the level of customer service, that a most traditional financial institutions can offer. Clearly online banks like USAA and Ally Bank have had success without any face-to-face customer interaction in place, but that doesn’t mean that kind of interaction doesn’t have value; on the contrary, it’s one of the biggest advantages that traditional banks have over their competitors.
Study after study has shown that offering a wide spectrum of services makes bank customers “sticky.” This innate advantage is only going to grow stronger in an era of hyper specialization; it may not matter how well a fintech company’s slick new app works, or how fast they can issue personal loans, if that’s all they can do. Building relationships with clients has never been more important, though it has to go hand-in-hand with embracing change, which brings us to the second strategic prong.
The Best Way to Beat Them Is to Emulate Them
If you boil down the fintech revolution to one definitive quality, it would be speed. Take the mortgage lending space, for example. The fintech lender Better.com lets potential borrowers get a pre-approval letter in three minutes, without even talking to a loan officer. Another digital mortgage lender, Eave, claims that borrowers can apply for a purchase in half an hour, obtain a full approval within 24 hours, and close in 21 days, guaranteed.
“It’s not the customer-facing stuff that’s been the driver of fintech success, it’s the behind-the-scenes improvements.”
These fintech lenders have taken a loan approval process that traditionally takes multiple contacts and processing stages, and, by automating it, made it essentially instantaneous. The good news is, smaller financial institutions can follow suit, with less disruption to their present business model than they might expect.
A lot of small traditional banks believe that they’ll have to rebuild their operations from the ground up in order to integrate fintech innovations. But this isn’t true. It will, however, require deeper changes than simply letting customers apply for loans online. It’s not the customer-facing stuff that’s been the driver of fintech success; it’s the behind-the-scenes improvements. Fintech lenders have cut down and in some cases eliminated many steps in the loan-approval process, such as the multiple follow-up requests to borrowers that can slow the process to a crawl.
Traditional lenders can use methods like parallel processing, automation, and data analytics to dramatically reduce their own turn times and, in some cases, get results that are even better than what’s achieved by fintech lenders. One traditional lender used these methods to improve their origination process, and achieved a 38% faster closing rate, with a 61% cost reduction.
The fact is, fintech lenders are the competition, but they’re not the enemy. If you can learn from their innovation, and couple it with the natural advantages of traditional banks, the future for brick-and-mortar lenders is brighter than it’s ever been.