The Next Chapter of Finance

The financial turmoil of 2008 was a rude eye opener to many who had taken the stability of the established banking and financial system for granted. The strict regulations and checks on risk taking, use of leverage etc. once thought to provide adequate cover to depositors and account holders were proven woefully inadequate. In the fallout that followed the public wanted greater transparency and control over their finances.

The timing proved fortuitous for many technology startups promising to do just that and may well have been the tipping point for companies such as Lending Club and OnDeck. These two companies provide peer-to-peer platforms that match lenders to borrowers, allowing people with excess cash to choose between many individuals and companies vying for loans on these platforms. Interest rates and terms are negotiated by the two parties, thus the business model is essentially a self-service bank. Both companies are far from experiments and are publicly listed. Lending Club has a market cap of more than 8 billion USD. Peer-to-peer money transfer, traditionally considered the domain of the banking system has become another red hot niche for fin-tech startups. Venmo, a mobile app that allows money transfers between peers, processes transactions worth more than a billion USD annually. It’s yet too early to predict the effects of these global developments here at home. Sri Lankan banking regulations currently don’t allow inward remittances on PayPal, much less crowdfunding equity or debt capital. The concept of companies raising equity over online platforms is still very new and only permitted in a handful of countries. Should these concepts catch on and prove successful there is likely to be a push for a local regulatory overhaul, particularly given the potential benefits such open marketplaces would bring in. Most small scale local entrepreneurs from farmers to fishermen rely on loan sharks for their day-to-day working capital. Many such entrepreneurs have no other avenue to raise finance and thus settle to pay astronomical amounts of interest for these short term loans. They also become bound to exclusive contracts – to sell their produce only to the businessman providing the loans. The overall result is inefficiency in the supply chain and distorted prices for consumers. An open online marketplace can clearly be of massive benefit, but would obviously need to apply new risk assessment models that can include unbanked sections of society.

This is another area that fin-tech startups are tackling with different clever new strategies for assessing individual and small business credit risk profiles. First Access, a startup active across Africa uses pre-paid mobile phone data ranging from the frequency of replenishing airtime, the types of data packages purchased, the number of text messages clients send, the timing of their calls, the manner in which clients interact with social networks etc. to assess individual credit worthiness. OnDeck the online lending marketplace uses everything from social media reviews of companies to usage of logistics firms to assess the health and credit worthiness of small businesses. While these models are yet to gain the same credibility as the traditional credit scores used by the banking sector, the growth rates of platforms such as OnDeck and First Access are driven by comparable if not lower default rates, a promising start indeed. It is worth noting that peer-to-peer marketplaces for finance are much more geographically focused and do not carry the leverage and associated risks of the fractional reserve banking system. The newcomers are thus contributing to the creation of a more diverse and stable credit landscape. Hidden fees by banks and financial networks to fatten margins are also coming under threat. Startups such as Transferwise are facilitating cross border transactions at a fraction of the cost of traditional methods such as Western Union and banks which charge a hidden fee in the form of currency conversion cost. The service is already available for India and would be a boon for Sri Lanka given its large expat worker population.

Currently all these services have only captured a fraction of the total market share and it’s unlikely that they will fully replace banks at any point. Archaic regulations and consumer perceptions of risk will hold back mass adoption for some time. However, a sector dominated by long established players always has room for disruption and we can cheer on the startups as they give the behemoths a run for their money.