Traditional lending works well. For the banks. For centuries, banking has remained fundamentally unchanged. In the simplest terms, banks match savers with borrowers. They pay interest for deposits and make loans to businesses and consumers. Depositors see their savings grow, borrowers use the capital. Banks profit handsomely on the spread.
Banks, as intermediaries, have always added to the cost of borrowing and lending – that’s the price we pay as a society for their market-making abilities. That spread represents a price that was accepted because the banks played a part in the community, and served community needs. Today, they do neither.
Consolidation has created national mega-banks that are more financial mega-stores than they are pillars of the community. And following the 2008 financial crisis and the regulation that ensued, non-mortgage lending has flat-lined.
In a publication from PricewaterhouseCoopers (PwC), they state:
“Traditional banks need to sharpen their strategic focus to remain relevant. By as soon as 2025 to 2030, a market economy could readily exist without banks as we have traditionally known them – a point reinforced by our second hypothesis. Banks still have some useful weapons to hand: their brands and reputations remain potentially powerful, and alternative banking providers still suffer from a lack of trust. However, many technology players have brands that could translate into the kind of trust necessary to challenge banks in banking services, should they choose to do so. Against this background, today’s banks must press ahead on four fronts, or risk slipping into irrelevance: they must continue to adapt to regulatory change; work through the legacy of underperforming assets; change their organisation’s culture and behaviours; and demonstrate to society that they deserve a renewal of trust and invest in customer service and operational innovation. Managing a transformation programme of this scale will be a challenge – but it is one the banks cannot afford to shirk.”
Basically, banks will have to revolutionise their lending methods to keep up with changes in technology, changes in customer demands and changes in customer expectations.
What’s causing these threats to traditional banking?
A number of alternative lending sources are becoming more prominent these days as people realise that, yes, there are alternatives to a bank. And often the alternatives offer better value for customers and are simply an easier way of borrowing money.
Some of the top alternative lending sources are:
Advance commission arrangements are a great way of making sure businesses have continuous cash flow. These lending arrangements are usually quicker and easier than having to go through a long and tedious bank loan application. This provides cash that’s readily available and is perfect for covering operational expenses such as salaries, IT investment and marketing spend at short notice.
Many online sites match small business owners looking for money with potential lenders. Businesses will usually post a profile with some background information and what they need the money for. Potential lenders then scour the profiles for possible investments. The site handles things like disbursement and record keeping, and will charge a percentage of the loan or a flat fee.
Websites that match up borrowers and lenders are enjoying a new wave of interest after a series of high-profile endorsements. According to The Guardian, Andy Haldane, executive director for financial stability at the Bank of England, said peer-to-peer lenders could eventually replace high street banks. “At present, these companies are tiny,” he said. “But so, a decade-and-a-half ago, was Google”.
Invoice discounting allows a business to draw money against its sales invoices before the customer has actually paid. To do this, the business borrows a percentage of the value of its sales ledger from a finance company, effectively using the unpaid sales invoices as collateral for the borrowing. It’s essentially the same as factoring – the business gets cash from its sales invoices earlier than it otherwise would – but the key difference is that the credit control remains with the business owner. This is not a service that traditional big banks offer, and is becoming an increasingly popular way of maintaining cash flow for businesses.
Alternative lenders offer shorter-term, higher-cost loans. The main characteristic of alternative lenders is their technology-driven decision making. Each lender has its own system to gather information and assess potential borrowers’ strengths and weaknesses. Many rely most heavily on bank statements and other financial data submitted by its applicants. But more recently, public databases and even social media activity have been factored into the decision-making process.
Traditional banking systems are changing rapidly to keep up with the demands of customers. But with the number of alternative lending sources growing all the time, who knows how we’ll be borrowing money in a decade’s time.