No Traditional Financial Institutions? No Problem

Editor’s note: Charles Moldow is a general partner at Foundation Capital.
On Lending Club’s February 2015 quarterly earnings call, an analyst asked CEO Renaud Laplanche a simple question: have you considered getting the loans you’re issuing rated? Renaud had a simple answer: We have, but we won’t.
As Renaud said, the marketplace lending platform’s loan grading system, which it illustrates on its website, is in many ways more transparent and more accurate than what a traditional rating agency can achieve. It’s a sign of good things to come – and not just in lending.
That brief exchange speaks to the transformation taking place right now across the entire financial sector, which is quickly turning into the financial technology sector, for several reasons.
First, banks today are inefficient and unloved. McKinsey measured a four-year period where just 30 percent of top global banks improved cost efficiency.
Second, millennials don’t feel beholden to banks. A Viacom survey of millennials showed that 33 percent believe they won’t need a bank at all and nearly half are counting on tech startups to overhaul the way banks work.
Third, traditional financial institutions are begging to be disrupted. In the past two decades, they’ve accounted for 20 percent of the market cap growth of all S&P 500 companies. Consider the incredible growth of other sectors in that same timeframe, like health care and technology. Financials outpaced them all – growing more than any other sector.
How is this possible at a time when consumers could hardly be less happy with their financial institutions? There are a number of explanations, but the clearest and most convincing is net interest spread: the difference between the yield banks receive from money they loan and the rate they pay to borrow.
Today, the spread is larger than it’s ever been in its history. Banks are borrowing from their depositors and from the Fed at historically low interest rates – as low as 0.5 percent here in the U.S. and at negative interest rates in countries like Germany. They turn around and lend at as much as 10 to 25 percent interest, depending on the borrower’s risk profile.
Since the Fed won’t lower rates further, this spread will likely narrow, and the party that banks have been having for decades will be over. Of course, that incredibly wide spread has opened up an equally wide opportunity for new entrants.
The companies best positioned to disrupt or even displace the incumbents will develop against four key elements, which consumers increasingly demand: simplify what is complex, increase transparency, offer analytics, and reduce friction. More information on these can be found here.
With these four maxims in mind, a range of exciting financial innovations become possible.
If buying insurance was as simple as buying an app, microinsurance would mean you only need to pay to mitigate the risks you actually take. If origination costs for loans approach zero, borrowers could refinance at their convenience or take advantage of changing interest rates to optimize their debt. If consumers utilized low-cost, cross border money transport via bitcoin, we could create a seamless global market. High-quality borrowers in third-world countries could easily be matched with high-quality lenders who have few high-yield options in their local market.
The possibilities number too many to count, but the market opportunity measures in at $2 trillion per year.
I expect most of that upside to be seized by innovative technology companies – because while the incumbents might seem too big to fail, all signs point to them being too slow to react.

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