Specialty finance, alternative lending, shadow banking, and internet enabled lending are a few of many titles used to broadly define lending activities, primarily technology based, conducted outside the typical banking system.
Digital enabled lending offers individuals an autonomized, technology driven approach to borrowing and lending money. It’s through this marketplace that borrowers and lenders are digitally paired. The borrower being an individual or small to medium sized business (SME), and the lender, a wide array of capital providers.
Although various forms of alternative finance have long existed, they have become much more popular through the wake of the 2008 financial crisis. Reconfigured regulation, repurposing technological capabilities and a shift in consumer perception towards certain banking activities have been the driving force behind this change.
Relative to the size of the overall unsecured lending marketplace, these digital alternative lenders have captured only a small percentage of market share to date, leaving considerable room for growth. In this paper we will explore the enabling factors that have led to a rise in decentralized industry players and the opportunity that has uncovered itself as a result.
New regulations are playing an integral role in developing the digital lending marketplace and have paved the way for new entrants and competition. A combination of factors including, but not limited to the Dodd Frank Wall Street Reform (U.S.) and Basel III, have forced banks into tightening their product offerings to consumers and small to medium sized businesses (SMEs). Thus driving clients into the arms of these new platforms.
This has led to reduced credit availability in some lending areas as it has made the cost of doing business more expensive for regulated banks. 1
This has led banks to pull back from dealing in some areas such as loans to non-investment grade companies. 1
Technology overall is best known for disrupting industries by taking a business model and redefining it with efficiencies in cost and time. This could not be truer for the evolution of the specialty finance industry.
- Convenience for the borrower
- The efficiencies of the system drives down the operating costs, leaving room for competitive interest rates to be passed on to the end client
- Big data analysis influences new ways of gauging credit worthiness
- The use of advanced technology to automate credit analysis, and processing has resulted in quicker loan decision making
Over the past decade, the general population of the western world has welcomed a digital lifestyle with both arms open. Increased online security standards and a cultural shift towards living professional and personal lives online has created a need to seek the most convenient, technological way in which to live our lives.
Specialty finance lending offers simplicity and convenience to the application process and provides a safe, familiar space for this activity.
There is an estimated $3.2 trillion of consumer debt in the U.S. 2 (Chart 1). To date, only 1%2 has been captured by the digital lending market, yet these companies are growing at an accelerated pace as both borrowers and investors recognize the advantages relative to the traditional bank lending model3 (Chart 2).
The European alternative finance market has seen significant growth in the past three years, from €487m in 2012 to €2,957m in 2014, with an impressive average growth rate of 146%4. (Chart 3)