How Banks Win with Alternative Finance

By Snehal Fulzele | 11 August 2016

The convergence of new technologies, the rise of alternative lending models, and evolving consumer behavior signal a chance for banks to evolve, grow, and thrive. Alternative finance (AltFi) creates new opportunities for banks. Agile new platforms and strategies such as marketplace lending and peer-to-peer lending, supported by new technology solutions, allow banks to stay competitive. Forward-looking banking institutions are developing partnerships with these alternative finance companies to grow their markets, share fundamental capabilities, and expand their expertise.

As astute banks leverage the latest advances in cloud technologies to modernise and simplify their organisations, they are delivering innovative digital experiences that meet the expectations of today’s tech-savvy customers while improving responsiveness to deal with market uncertainty.

Today’s banks face numerous challenges. Forward-looking banks see these challenges as opportunities to transform their strategies. We see the following trends:

  • The Rise of Alternative Finance

New forms of lending bypass the core functions of traditional banks. Banks face increasingly heavy competition from new players such as online lenders, peer-to-peer lenders, and marketplace lenders. Within these open marketplaces, borrowers can interface with investors without the involvement of a traditional bank. Marketplace lenders rely on efficiency, a superior customer experience, transparency, and trust to satisfy customer demand.

  • High Borrower Expectations

Highly connected users demand more immersive experiences from the organisations they do business with. Led by Millennials, these users are motivated by liberating experiences with social media, online commerce, and the steady digitisation of content. Advanced mobile devices set the bar for new functionality as consumers look to technology to make their lives easier, ushering in a wholesale consumerisation of many traditional information systems. Most banks trail the market in their ability to give customers a rich, interactive borrowing experience.

  • New Regulations

Regulations have a tremendous impact on today’s banks. Since the financial crisis of 2008, stricter lending standards have dramatically impacted the ways banks work. Pressure from customers—especially the taxpayers who bailed out these financial institutions—has led to an over-reaction in regulation.

  • Higher Operating Costs

Banks have higher operating costs as a percent of loan balances versus marketplace lenders due to operating inefficiencies. Banks are operating with existing legacy systems that make responding to competitive pressure from alternative finance companies costly and time consuming. Legacy banking systems are siloed and not well integrated, impacting the overall customer experience. Alternative finance companies operate on a cloud-based, single system of record technology platform that results in stronger know-your-customer capabilities and superior user experiences. Furthermore, banks are further disadvantaged by their reliance on legacy systems that automate core operations and ensure regulatory compliance. These extra burdens, not experienced by alternative finance companies, increase banks’ operating costs.

The Emergence of AltFi

Alternative finance is thriving as new technologies expand the options available to consumers and lenders. The latest online business models are fueled by the emergence of technologies that make it easy to lend and borrow—anytime, anywhere. A noteworthy example is marketplace lending, which is art of the peer-to-peer lending phenomenon. Peer-to-peer lending involves lending money to individuals or businesses through online services that match lenders directly with borrowers. Those borrowers can meet investors in a virtual marketplace without the involvement of a traditional bank.

A few essential characteristics differentiate these nimble AltFi companies from traditional banks:

  • They have no branches. Instead they offer digital experiences for processing and servicing loans
  • They can set their own interest rates, service their own loans, and/or sell their loans to other investors
  • They collect lots of data to analyse market trends and discern customer behavior, rather than merely relying on FICO to build credit models

The incentive for banks to modernise is likely to grow as tech-savvy Millennials, who have little loyalty to banks, begin to control progressively larger shares of the world’s financial assets. According to the Democratising Finance Report, Millennials are ten times more likely than Baby Boomers to utilise peer-to-peer lending, and at least 14 percent of Millennials are already utilising alternative, non-bank financing. A global easing of regulations has opened up the private investment market to a larger number of investors. As a result, the global alternative finance market was estimated to grow to $34.4 billion in 2015. In fact, according to an anonymous research, “Banks do not have the best reputation when it comes to innovation. Digital lenders create a competitive edge by using technology to their advantage.”

Alternative lenders analyse relationship data to provide a differentiated experience to their customers. They expand the lending landscape by servicing consumer loans, student loans, real estate loans, and small-business loans. The strategies and technologies used by these AltFi competitors represent an opportunity for banks to evolve.

By Snehal Fulzele, CEO and Co-Founder, Cloud Lending Solutions.

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