Fin Tech as a Disruptor of Financial Services

Reena Aggarwal

Robert E. McDonough Professor of Finance

Director, Georgetown Center for Financial Markets and Policy

FinTech as a Disruptor of Financial Services

Disruptive Innovations in Financial Services

Institute for Financial Services Analytics

Alfred Lerner College of Business & Economics

University of Delaware

March 2016

Disruption in Financial Services

• Address societal challenges

• Financial inclusion

• Inequality issues

• Access to capital

• SMEs

• Our work with the World Economic Forum/World Bank

•FinTech: Use of technology and innovative business models in financial services

•Companies provide financial services through the use of technology

– These companies provide products and services to users through online and/or

mobile channelsFinTech

Characteristics

Innovation

•Innovative solutions have disrupted the traditional financial services industry

•Promises to include un-served and under-served markets

•Have increasingly provided funding for SMEs especially after the Great Recession

•Face lower costs

Focus

Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015

•Single-purpose solutions: Offer a better experience in a single product or service

•New sets of products: Tailored for small businesses


Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

Factors Enabling the Industry’s Growth

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor


Regulation

Regulated banks face higher costs for lines of business FinTech

firms are tapping into

Technology

Macro

Environment

Big data analytics increasingly available

Online financial transactions, alongside big data analysis, have

lowered costs and increased speed

Low interest rates and low loan default rates allow for credit

creation; the former has increased the demand for loans while the

latter has increased investors’ willingness to lend

Investors are seeking assets with higher yields & are comfortable

with higher risk profiles of borrowers

Risks

1. Limited

investor

protection

2. Defaulting

borrowers

3. Systemic

risk

associated

with lack of

regulation

The Growth of FinTech


• Reduced the availability of credit for individuals and small businesses

• Triggered regulations that have since hampered traditional banks’ ability to meet the needs of SMEs, among others

• Big opportunity for FinTech firms

Great Recession

2007-2008 2005-2011 2013-2014 2015

New players emerged:

• Prosper (2005)• Lending Club (2006)• OnDeck (2006)• Kabbage (2009)• SoFi (2011)

New Players

Investment in FinTechcompanies grew by fourtimes in one year,reaching $12 billion in2014

Threat to Banks

• 68% of bank respondents believe their small business lending activities were under “high threat” from FinTechfirms

Growth

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor


Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor


Approval

Rates for

Small

Business

Loans

0% 10% 20% 30% 40% 50% 60% 70%

Alternative Lenders

Institutional Investors

Credit Union

Small Bank

Big Bank

0%

10%

20%

30%

40%

50%

60%

70%

Millennials Gen X Boomers Matures

Millennials Prefer Online and

Mobile More than Other

Generations

Online Giving Mobile Giving



Facts

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

Mobile P2P payments in the U.S.

reached $16bn in 2015 and are estimated

to reach $86bn in 2018

P2P loan issuance grew by 65

times from 2009 to 2014 on

Lending Club and Prosper,

reaching $1.7bn

Non-banks’ share of

mortgage originations went from 10% in 2009 to 42% in

2014

60-80 countries already

have a lending platform or one

expected to launch soon

$1.5

$2.7

$5.1

$10.0

$0.0

$2.0

$4.0

$6.0

$8.0

$10.0

$12.0

2011 2012 2013 2014

Fu

nd

ing

in

Bil

lio

ns

Year

Aggregate Amount of Funding Through Crowdfunding



Facts

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

Kickstarter crowdfunding platform has reached

$1.6 bn in pledges alone, its largest campaign

raised $17+ million

The Growth of FinTech


0

2

4

6

8

10

12

14

Year 2013 Year 2014

Inv

estm

ent

in B

illi

on

s o

f U

SD

Investment in FinTech Firms

27%

16%

57%

Breakdown

Consumer Lending Business Lending Others

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

Lending


Business

Models

Models:

• Balance sheet lenders

• Marketplace lenders

• Hybrids

Focus on:

• P2P lending, Small business lending, Leveraged lending, Student lending,

Mortgage lending, Commercial Real Estate Lending

Key

Characteristics

• Unsecured lending

• Either mediated or direct flow of funds

• Retail or institutional investors

• Innovative credit scoring models

• Low cost structure and more accurate pricing

• Less regulatory obligations and capital requirements than bank

counterparts

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

Practice of lending money to borrowers without traditional financial intermediary

Market Segments, Business Models, and the Main Players

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor


Lending

Merchant and e-Commerce Finance

Invoice Finance

Supply Chain Finance

Trade Finance

Lending

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor


Lending Club and Prosper had 129% CAGR in collective originations 4Q09 to 3Q14

Main Players Description

• P2P lending platform founded in 2006, IPO’d in 2014 (LC)

• Biggest player, yet only has 2% of market share ($4bn in

$240bn market)

• Founded in 2005, focuses on P2P lending and remains

private

• Took 8 years to reach first billion, only six months to reach

second

• Founded in 2006, focuses on business lending

• Quarterly origination volume grew from $61mn/qt in 4Q12

to $313mn/qt in 3Q14; currently has $433 million in loans

outstanding

• Founded in 2011

• Offers refinancing options for students

• No residual risk on originated loans

Lending


Enablers for

Growth

• Data availability

• Supportive regulation

• Risk-taking investors

• Educated borrowers

• Effective platforms

• Third-party service providers

• Socialization of finance

Risks

Outlook

• Investors’ lack of experience

• Making access to capital too easy

• Sustainability and stability still to be tested

• Systemic rick arising from unregulated sector; regulation likely to increase

• Millennial small business owners are 5 times more likely to use

P2P lending than Boomers

• Consolidation

• Internationalization of payments

• Industry formalization

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

Lending


Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

How Does it Work?

Lending

Club

Partner Bank

(not owned by lending platform)

Investors, banks, institutional

whole loan buyersBorrowers

(1) Application(2) Commitment

(5) Cash

(9) Loan Note

(8) Origination Fee

(6) Cash

(7) Loan Note

(4) Loan Note

(3) Net loan proceeds

FinTech Firms in Lending Benefitted from Changes in Regulation


Changes in regulation are driving businesses out of traditional banking system and into new players

Lending Product Regulation Impact Opportunities

Personal

• CARD Act

• Stricter capital requirements

Diluted returns for banks from higher

capital requirements

Increased credit card interest rates

Non-banks not subject to higher capital

requirements

Can price below banks

Small Business• CCAR

• Focus on concentration and pricing

Regulated banks unable to price risk

in lower credit loans

Non-banks can change to higher rates

on loans with higher risks

Leverage• OCC Guidance, “Skin in the game”

rules for securitizers, CCAR

Regulated banks unable to take on

riskier deals

Non-banks tap into riskier deals

Commercial Real Estate• Basel III

• CCAR

Diluted returns for banks from higher

capital requirements

Other lenders can tap into more

complex deals

Mortgage Banking

• Basel III, Home Mortgage Disclosure

Act, Qualified Mortgage rules for

underwriting, “Skin in the game”

rules for securitizers

Banks have to sell MSRs and decrease

number of mortgage originations

Non-banks have doubled their market

share in mortgage origination

Student

• More oversight by CFPB, 2010

elimination of FFEL loan program,

possible student loan bankruptcy

reform

Big banks stopped originating student

loans, divesting into run-off portfolios

Marketplace lenders’ business model

focused on refinancing student loans at

lower rates

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

Lending


Market Overview

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

FinTech lending platforms accounted for $60-70

billion in outstanding loan volumes in 2014

Loans worth $40 billion in China and $5

billion in the U.S.

Total addressable unsecured consumer loan

market estimated at $270 billion, out of

which Lending Club and Prosper, the two largest

players, have 1.8% market share

0

2000

4000

6000

8000

10000

12000

14000

Crowdfunding Wealth Management Payments Unsecured Personal

Lending

Small Business Loans Student Loans Annual Loan

Origination of

Mortgages

Market Size (bn)

Immediately Addressable (bn)



Broad Opportunities

Millennials are 5 times more likely than Boomers

to use P2P lending for their small businesses

HENRY’s: Tapping into

under-served markets,

the High Earners, Not Yet Rich

Business

Models

Market

Segments

Going

Forward

Major

PlayersGrowth

FinTech

Disruptor

$4 trillion of immediately addressable revenue in

the socialization of finance sector

50% of Millennialsbelieve tech start-ups will

overhaul banks

33% of Millennials believe they will

not need a bank in 5 years and only 50%expect to use cash on a weekly basis by 2020

Risks Going Forward

• Regulatory Response as FinTech firms become large

• Funding Sources

• Lending Laws

• Operational Structure – technology risk, data protection,

relationship with traditional banks

• Incumbent banks will respond – JP Morgan & OnDeck

• Consolidation

Regulatory Uncertainty Going Forward

China

People’s Bank of China: Online Payments

China Banking Regulatory Comm: Peer to Peer (P2P)

China Securities Regulatory Comm: Crowdfunding

China Insurance Regulatory Comm: Online Insurance