Breaking Banks E-Book

Brett King

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch
• Veröffentlichungsjahr: 2014

Seitenzahl: 540

Beschreibung

"In the next 10 years, we'll see more disruption and changes to the banking and financial industry than we've seen in the preceding 100 years"--Brett King Breaking Banks: The Innovators, Rogues, and Strategists Rebooting Banking is a unique collection of interviews take from across the global Financial Services Technology (or FinTech) domain detailing the stories, case studies, start-ups, and emerging trends that will define this disruption. * Features the author's catalogued interviews with experts across the globe, focusing on the disruptive technologies, platforms and behaviors that are threating the traditional industry approach to banking and financial services * Topics of interest covered include Bitcoin's disruptive attack on currencies, P2P Lending, Social Media, the Neo-Banks reinventing the basic day-to-day checking account, global solutions for the unbanked and underbanked, through to changing consumer behavior Breaking Banks is the only record of its kind detailing the massive and dramatic shift occurring in the financial services space today.

Leseprobe

Contents

Acknowledgments

About the Author

Introduction: An Industry Being Reborn and Reinvented

Chapter 1: A New Take on Credit and Lending

When Your Credit Score Becomes More Important Than Actual Risk

Taking a Fresh Look at Lending

A Different Type of Credit Assessment Based on Community

Through the Looking Glass: Lending 3.0??

The Key Lessons

Participant Profiles

Notes

Chapter 2: The Era of the Faster, Smarter Payment

What Does History Teach Us about Payments?

Disrupting Payments, and Making Payments Disappear

The Internet Changes the Rules

Do We Need Common Standards or Banks in the Payments System?

When Innovation and the Free Market are Not Enough

Through the Looking Glass: The Invisible, Instant Payment

The Key Lessons

Participant Profiles

Notes

Chapter 3: Banks That Build Their Brand without Branches

The Historical Use of the Web

Solving the Revenue Problem

What Happens When Alternative Channels are Your Only Revenue Source?

A New Approach to Banking, or Hedging the Branch Bet?

The Key Lessons

Participant Profiles

Notes

Chapter 4: How the Crowd Is Changing Brand Advocacy in Banking

Social Media is Just Getting Started

Building Brand through Community

Social Banking from Down Under

Organizational Approaches to Social Media: Ban or Boost?

The Key Lessons

Participant Profiles

Notes

Chapter 5: Not Your Father’s Banking Habits

The “See-and-Hear” Generation

Advocacy is Built through Seeing and Hearing a Brand

The De-banked Generation

How Branch Economics are Changing with Behavior

Why Banks are Comparatively Poor Profit Engines

Would Google, Facebook, or Apple be Better at Banking?

What will the Future Bring?

The Key Lessons

Participant Profiles

Notes

Chapter 6: Is Bitcoin the End of Cash?

Bitcoin Is “Real”—Deal with It

The Death of Cash by “a Thousand Cuts”

The Digital Money Everyone’s Talking About

The Case for a Legitimate Digital Currency—Canada’s Mint Chip

Will Digital Cash Kill the Dollar?

The Key Lessons

Participant Profiles

Notes

Chapter 7: Moving from Personal Financial Management to Personal Financial Performance

Information and Content Is Not Advice

Geezeo: The Core Goals of PFM

Money Desktop: Where Visualization Is Key

The Role of Interface and Real-Time Messaging

The Key Lessons

The Participants

Notes

Chapter 8: When Technology Becomes Humanlike, Does a

Real

Human Provide a Differentiated Experience?

How Design and Computing Power Has Changed the Role of Technology

Can Voice Recognition Solve Our Identity and Service Challenges?

The Key Lessons

Participant Profiles

Notes

Chapter 9: Here Come the Neo-Banks!

Are Innovators Disrupting Traditional Retail Banks?

Making Banking “Simple”

Time to @getMoven!

Bluebird Takes Flight

Will the “Bank” Ever Disappear?

The Key Lessons

Participant Profiles

Notes

Chapter 10: Building Experiences Customers Love

The Failings of Broadcast Brand Recall

Building Advocacy, Not Recall

Engaging the Customer 3.0

The Future of Engagement: Beyond Marketing

The Key Lessons

Participant Profiles

Notes

Chapter 11: Money

Can

Buy Happiness

The Real Cost of Loyalty and Frequency

Enter Smartphone Loyalty

The Key Lessons

Participant Profile

Notes

Conclusion: We’re Not Breaking Banking, We’re Rebooting and Rebuilding It

Index

End User License Agreement

List of Illustrations

FIGURE 1.1 UK & US Household Debt as a % of Total Income

FIGURE 1.2 Total Loan Issuance (LendingClub.com)

FIGURE 9.1 U.S. Bank Branch and Deposit Aggregates Since 2000

FIGURE 9.2 U.S. Banking Transactions by Channel

FIGURE 9.3 Predicted Decline in U.S. Branch Numbers from 2012

FIGURE 10.1 TV Ad Spend (Inflation Adjusted) Declining 30 Percent in the Past 15 Years (in millions of dollars)

FIGURE 10.2 Newspaper Ad Revenue Now Below 1950s Levels

FIGURE 10.3 Mobile Advertising Exploding in the Last Few Years

FIGURE 10.4 Google Advertising Revenue Outstripping Traditional Print Advertising in 2012

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Guide

Cover

Table of Contents

Begin Reading

Breaking Banks

The Innovators, Rogues, and Strategists Rebooting Banking

Brett King

Cover image: ©Tiero / 123RF

Cover design: Wiley

Copyright © 2014 by John Wiley & Sons Singapore Pte. Ltd.

Published by John Wiley & Sons Singapore Pte. Ltd.

1 Fusionopolis Walk, #07-01, Solaris South Tower, Singapore 138628

All rights reserved.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as expressly permitted by law, without either the prior written permission of the Publisher, or authorization through payment of the appropriate photocopy fee to the Copyright Clearance Center. Requests for permission should be addressed to the Publisher, John Wiley & Sons Singapore Pte. Ltd., 1 Fusionopolis Walk, #07-01, Solaris South Tower, Singapore 138628, tel: [phone], fax: [phone], e-mail: [email protected].

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor the author shall be liable for any damages arising herefrom.

Other Wiley Editorial Offices

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ISBN 9781118900147 (Hardcover)

ISBN 9781118915318 (ePDF)

ISBN 9781118900154 (ePub)

This book is dedicated to Matt, my son, who is learning to code and has more potential than he can imagine, and to the Italians who invented modern-day banking.

The measure of intelligence is the ability to change.

—Albert Einstein

Acknowledgments

There are a few people whose support made Breaking Banks and the ongoing disruption possible. First, thanks to Rachel Morrissey, who keeps me sane and keeps everything going, and to Randall and the team at Voice America for giving me the opportunity to run the Radio Show that led to this idea in the first place. Second, thanks to the amazing participants and interviewees who gave their time and support for the book, all of whom were very patient through rounds of edits and other unintended consequences.

Thanks to the team and supporters of Moven, who continue to give their incredible support in this tough, but amazing journey; to the tribe of bloggers, friends, and supporters who regularly tune in each week to my show, tweet, and amplify the message, including Sudu, Jim Marous, Dave Birch, Brad Leimer, Dave Gerbino, Serge Milman, Robert Tercek, Bruce Burke, Duena Blomstrom, Mike King (no relation), and cover artwork designer J. P. Nicols (no h), Ron Shevlin, Deva Annamalai, Jeff Stewart, Matt Dooley, John Owens, Bryan Clagett, Jason Cobb, Adam Edge, Jenni Palocsik, Matt West, Jay Rob, Lydia, and the crowd of other followers whom I’m sure I’ve missed; and to Uday Goyal, Sean Park, Sim, Pascale, Naoshir, Nadeem, Yann, and the team at Anthemis, who never cease to amaze me with their network and support.

Thanks to Nick Wallwork, Jeremy Chia, and the team at John Wiley & Sons for their support.

Thanks to Jay Kemp, Tanja Markovic, Jules, and the team at ODE, who support my efforts to keep the disruptor message loud and clear on the road about 100 days of the year.

Finally, thanks to the disruptors, innovators, engineers, entrepreneurs, investors, and believers who are changing the world of banking every day.

About the Author

Brett King is an Amazon best-selling author, a well-known industry commentator, a speaker, the host of the BREAKING BANK$ radio show on Voice America (an Internet talk-radio network with over nine million monthly listeners), and the founder of the revolutionary mobile-based banking service Moven (Moven.com or search iTunes/Google Play for “Moven”). King was voted as American Banker’s Innovator of the Year in 2012, and was nominated by Bank Innovation as one of the Top 10 “coolest brands in banking.” His last book, Bank 3.0 (available in seven languages), topped charts in the U.S., U.K., China, Canada, Germany, Japan, and France after its Christmas 2012 release.

King has been featured on Fox News, CNBC, Bloomberg, and the BBC, and in Reuters, Financial Times, The Economist, ABA Journal, Bank Technology News, The Asian Banker Journal, The Banker, Wired magazine, and many more. He contributes regularly as a blogger on Huffington Post.

Introduction: An Industry Being Reborn and Reinvented

The premise of disruption in financial services is relatively new. With the exception perhaps of the push for deregulation in the 1970s, banking is not known for huge leaps in innovation or significant shifts in the dynamic of the players involved. Sure, there have always been mergers and acquisitions, and some industry consolidation from time to time, but there’s never really been anything that is akin to the level of disruption we’ve recently seen in the music or publishing industries, for example, or the dynamics of the communications sector with the shift from the telegraph to the telephone, and then from fixed-line to mobile.

In the midst of the financial crisis in 2009, Paul Volcker, the former U.S. Federal Reserve chief, berated the financial industry in respect to its track record on innovation:

I wish somebody would give me some shred of evidence linking financial innovation with a benefit to the economy.

—Paul Volcker commenting at the Wall Street Journal’s Future of Finance Initiative, December 7, 2009

Volcker went on to claim that the last great innovation in banking was, in fact, the ATM machine. Volcker has a point. In all, banking hasn’t really changed materially in hundreds of years. Ostensibly, the nineteenth-century form of the bank branch is still largely recognizable today. While we have had some so-called branch of the future concepts, the way we do banking has remained largely unchanged over the past hundred years.

At least, that was true up until a few years ago when the Internet emerged. Today, we see significant shifts in banking, consumer behavior, and bank product and service distribution methods. We have seen dramatic changes wrought by technologies like the Internet, social media, and mobile banking. The recent global financial crisis has undermined trust in bank brands collectively, and while that trust may start to return in the coming months, for now it is a cause for open challenges to the traditional banking approach. We have social media and community participation giving transparency to the discussion on bank effectiveness, customer support, and fees, like never before. We have new disruptive models of banking, payments, and/or near-banking that are taking off and challenging the status quo.

It is entirely possible that banks, with their heavy regulatory burden, high capital adequacy requirements, massive legacy infrastructure, and long-held conventions, may just have trouble adapting to these tectonic shifts. Think of Kodak, Borders, and Blockbuster as examples of companies in other industries that have succumbed to disruptive business models, changing consumer behavior, or technology shifts.

However, it is also possible that some banks may survive intact because they can direct their not-insubstantial resources to evolving the big ship that is their bank brand and operations, and can put a new layer of innovative customer experiences and technologies over the old core, creating something new, something dynamic and adaptive. Right now, however, the former looks considerably more likely, purely because the inertia in banking is fairly well embedded around risk and compliance processes, regulatory expectations and enforcement, and those 30-to-50-year-old legacy IT systems that can’t easily adapt to the always-on, über-connected environment we live in today.

In May 2013, when I established a podcast radio show1 to tackle these concepts and questions, I set out with the intent of regularly interviewing the most disruptive players in the financial services space who are challenging the norms and attempting to turn traditional banking on its head, along with some of the most innovative leaders from within the sector trying to stay competitive. These two groups of disruptive innovators might represent different sides of the same problem, and while their approaches differ, the key takeaways or lessons they provide are extremely enlightening.

This book is not just a summary of those interviews; it is an examination of the new emerging business models, concepts, approaches, and constructs from a strategy, technology, and success point of view—what is working, and what isn’t. More importantly, we look at what traditional players can learn from these innovators to kick-start their own projects or initiatives, and what they have at risk if they don’t listen and learn. The interviews are insightful and take us in new directions, but also act as case studies of some of the techniques and models that are setting the tone for the next 20 to 30 years of banking. The data collected around these interviews and concepts is designed to give depth to understanding those models and providing statistical or quantifiable support for the various strategies.

In the chapters that follow, you will read about topics that include P2P lending, Bitcoin, and digital or cryptocurrencies, neo-banks or neo-checking accounts that challenge the basic bank account premise, social media’s impact on major bank brands, banks that have had dramatic growth despite no branch network support, leading indicators of changing consumer behavior, sustainable banking, financial wellness and the tools that help people save, how campaign marketing is disappearing and customer journeys are emerging, and how technology is becoming elegant, highly usable, and more responsive to the end consumer. These are the new core competencies of retail financial services.

The secret sauce of these new innovative approaches, however, is really still down to the individuals driving that change on a day-to-day basis. This is not just about implementing the right technology or whether you integrate social media or mobile into your customer-facing strategy. This is about what drove these innovators to try something different, and where they see the industry going next.

In each chapter, I ask these industry leaders what the next 5 to 10 years will bring. In many ways, this is my favorite part of the dialogue, because it shows that potentially some of the revolutionary approaches to banking, lending, and customer engagement we are experimenting with today will be far more disruptive on a longer-term basis to banking than we can even imagine.

These are some of the most innovative disruptors in the banking scene today. Listen to what makes them and their businesses tick. Listen to what drove them to start these new approaches in the first place, to challenge the norm. Most of all, however, just imagine where this will take us next.

These are the Innovators, Rogues, and Strategists rebooting banking—perhaps even Breaking Banks.

NOTES

1

Breaking Banks

is in its first year but is already in the top-five business shows on the Voice America/World Talk Radio network, which is in turn the most popular online radio station and the most popular podcast channel on the Apple iTunes network.

Chapter 1A New Take on Credit and Lending

The Global Financial Crisis saw the first decline in household debt in countries like the United States and the United Kingdom in over a decade, but in the past months we’ve started to see the lending business warm up again, getting closer to its pre-Financial Crisis levels.

When it comes to loan origination, traditional lenders increasingly are finding difficulty in competing with digital services and platforms that are providing more information and options in a more dynamic manner. Approval times have been slashed, built on newly designed processes with far less friction than the typical lender’s loan application. As mistrust of the traditional banking system has increased and as lending has become more expensive, entrepreneurs have been turning to tools of the digital age to offer new solutions to those such as the unbanked, or to those looking for more transparent or cost effective options.

Lending has been around for a very long time. In fact, lending predates formal currency and the formalized banking system by thousands of years.

Archeological digs over the past 150 years or so have found literally hundreds of thousands of these tablets from as far back as 3000 BC. These tablets reveal that silver and barley (and sometimes gold as well) were used as the primary currencies and stores of wealth at the time. Mesopotamian merchants and lenders granted loans of silver and barley, at rates of interest fixed by law1 to avoid usury. The yearly interest on loans of silver was regulated at 20 percent and on loans of barley at 33.3 percent.

Close to 4,000 years later, we’re still using this same basic construct for lending purposes—a principal, a term, and an interest rate.

Access to lending has today become cheap and ubiquitous. Credit in the form of auto loans, student loans, payday loans, mortgages, and credit cards has sprung up across the developed world in increasing variety. Microcredit and lending systems, most recently popularized by the likes of Grameen Bank2 in Bangladesh, and new online social platforms, such as Kiva.org,3 have given broader access to credit in communities that have traditionally not had access to such.

Our dependence on credit and the way we use credit has also changed in recent years. In the early 1980s, U.S. household debt as a share of income was around 60 percent. By the time of the 2008 financial crisis, that share had grown to exceed 100 percent. In fact, at its peak just prior to the financial crisis, U.S. household debt as a share of income had ballooned to almost 140 percent, but in the United Kingdom that figure was almost 170 percent of household income. Today, U.S. household credit card debit alone averages $15,185 per household, but that is down from around $19,000 in mid-2008 (Figure 1.1).

FIGURE 1.1 UK & US Household Debt as a % of Total Income

Source: Federal Reserve, BLS, Office of National Statistics (UK).

The good news (for consumers) is that after the financial crisis we’re using debt less in countries like the United States and the United Kingdom. In fact, we’ve seen a roughly 20 percent decrease in household debt as a percentage of income since the financial crisis, bringing use of household debt back to around 2002 levels. The bad news is that with default rates skyrocketing during the financial crisis, this reduction is less about people saving money, and more about the fact that defaults increased dramatically.

At the heart of this increasing debt load we see in developed economies is a system that is built around lack of transparency on the real cost of lending, and lack of visibility on your money.

In the 1960s, when debt utilization was low, the bank account of the day was a Passbook, and there were no ATMs, credit cards, or debit cards. If you wanted to spend money, you had to take your passbook down to the branch, withdraw cash, and you would see very obviously how that withdrawal affected your overall financial position. You also couldn’t generally spend more money than you had in your bank account. Overdrafts were uncommon, checks would bounce if you didn’t have enough cash in your account, and the most common form of financing was a home mortgage (not a credit card).

Today, our use of credit cards and debit cards has actually decreased visibility on our velocity of spending. For the 68 percent of American households that live paycheck-to-paycheck,4 this can be problematic. Try as we might to keep a rough estimate of how we spend our money on a day-to-day basis, most of us are just not that accurate in keeping track of our running bank balance. Inevitably, then, consumers end up in a store shopping for the week’s groceries, they pull out that debit card, and the transaction is declined because they’ve simply spent more money than they were aware of. Or, worse, they suddenly are in overdraft and don’t find out until they next go to the ATM and find their account $300 in the red due to overdraft fees.

The way we use credit in our lives is going to have to change. Visibility on the real-cost of debt, whether student loans, mortgages, credit cards, or things like medical loans in the United States, is going to face demand for greater transparency when it comes to consumer awareness on the real costs involved. At the same time, credit decisioning is going to go through a rapid change in the next decade as most of these decisions become real-time—no longer based on some application form you fill out sitting in a branch, but triggered contextually and based on a risk methodology built more from consumer behavior than historical default.

WHEN YOUR CREDIT SCORE BECOMES MORE IMPORTANT THAN ACTUAL RISK

In 2010, I moved to the United States, and despite a healthy income profile,5 a spotless credit history outside of the United States, a healthy net cash position, a strong investment portfolio, and minimal ongoing credit exposure, I still couldn’t get basic credit for love or money.

The problem is that the U.S. system has become so dependent on credit scores that good risk decisions can no longer be made without reference to that score. In the minds of many, credit scores appear to have become more about punishing borrowers for perceived bad behavior than actually providing access to credit.6 Most credit scores often lag7 30 to 60 days behind consumer behavior (rather than accurately predicting the likelihood of default as they are supposed to), and consumers often see a markedly different credit score than what lenders see.8

With my income and risk profile I was a very safe bet for any lender or credit facility, but because I hadn’t meticulously crafted a credit score history, I was a nonentity as far as lenders were concerned—and that translated to a false negative, a presumed “guilty,” because I had what is known in the industry as a thin credit file. If a bank had examined my behavior, they would have seen that each month I save, and I spend considerably less money than I earn—and therefore my ability to service ongoing debt is very high. Additionally, my income has been improving consistently over the last four to five years, so that trend should mean that my ability to service debt is actually improving. None of that mattered. The logic of a sound credit decision based on actual risk had been replaced by another mechanism—a standardized score that was not a good predictor of risk without at least a two-to-three-year history or investment in building up that score specifically.

Now it is a fair argument that in a system that demands real-time or rapid access to credit facilities, perhaps even in-store at the time of a purchase, you need some sort of automated system that assesses credit risk. In the absence of a better system, maybe credit scores or credit agencies are the best approach we have? That might have been true back in the 1980s, but today the U.S. Public Interest Research Group has reported that the current system is generating erroneous credit reports 79 percent of the time.9 In addition, the system is expensive, results in poor default management, and is designed primarily to protect the lenders, rather than positively facilitate the borrowers, even when they have a low or moderate credit risk profile. In the end, the best credit scores go to good, regular users of credit, rather than customers who choose to take credit only when they can’t avoid it.

One accepted measure of overall credit risk management performance for lending institutions today is default rate, more specifically expressed as a charge-off rate. During the Global Financial Crisis (also known as the “Great Recession” or “GFC”) banks like Bank of America (BAC) saw default rates on mortgages skyrocket to 24 percent in 201010 and credit card defaults of 13.82 percent in 2009.11 Today BAC’s default rate on mortgages stands at a nominal 6.7 percent,12 and credit card defaults have also declined nationally. The Federal Reserve puts charge-off rates on mortgages/real-estate loans at 2.32 percent in Q1 of 2013, and 3.8 percent on credit cards.13 Lending Club, the largest peer-to-peer (P2P) lender in the United States, has an effective default rate of 3 percent on its current portfolio, which is extremely competitive based on the current market.14

In the past two to three years, P2P lending has improved its viability as a new asset class and maintained respectable default rates. Lending Club has now surpassed $3 billion in total loans (Figure 1.2) and that has more than doubled the $1.2 billion in total loans facilitated that they recorded in just January 2013.15 Considering they just passed $500m in loans back in March 2012, that is a phenomenally successful growth curve. Lending Club maintains an average annual interest rate of 13.34 percent, compared to the national 14.96 percent average APR on credit cards.16 As of January 1, 2013, Lending Club had produced average total returns of 8.8 percent on “savings” over the previous 21 months of operation. During the same timeframe, the S&P 500 has had 10 negative quarters, and yielded average total returns of 4.1 percent.

FIGURE 1.2 Total Loan Issuance (LendingClub.com)

For the high-credit-quality borrowers we serve, our risk-based pricing model often represents hundreds or even thousands of dollars in savings over traditional bank credit cards, which would charge them the same high rates as everyone else. Our rapid growth is being driven by those high-credit-quality borrowers who have been underserved by the traditional model.

—Renaud Laplanche, CEO, Lending Club17

P2P propositions in other markets are rapidly growing, too. Zopa in the United Kingdom has lent over £400m to date, and the total U.K. P2P industry now is approaching £800m (including the likes of Ratesetter and Funding Circle). But perhaps more interesting, Zopa’s growth is increasing with growth of 60 percent + year on year (YoY) and a recent run-rate of 90 percent YoY growth over the last 2 months, with £144m of their current portfolio having been lent in the last 12 months.18 Zopa’s defaults are at 0.5 percent and with average loan rates of 6.7 percent,19 which represents best-in-industry performance, and are around half the default rate of the top-performing banks in the United Kingdom.20

P2P lending now represents roughly 3 percent of the U.K. retail lending market (non-mortgage lending).21

TAKING A FRESH LOOK AT LENDING

Interviewing Giles Andrews, CEO and cofounder of Zopa, was a fantastic way to dive into some detail on why P2P is performing so well compared to traditional credit and lending methodologies, and why their default rates are a fraction of the big banks in the United Kingdom, particularly in Zopa’s case.

Brett: Giles, let me ask you, first of all, to tell us a bit about Zopa. What is Zopa? When did you start the business? What was the objective of Zopa, and where are you today?

Giles: Zopa was the first peer-to-peer lending business in the world. We launched it in March 2005. Peer-to-peer lending is a bit of a mouthful, but what we do is really simple. We connect people who have some spare money with people who want to borrow it. And, by doing so, cut out banks in the middle, so that both parties get a better deal. We had a simple aim, which was to provide greater efficiency in what we saw as a very inefficient financial sector—by providing better value to consumers on both the saving and the borrowing side of the trade.

Brett: You were the first in the space, so what led you to believe there was demand for a fundamentally different approach to lending in this respect?

Giles: I think the first thing we thought about was a question: “Why is it that consumers get a much worse deal out of financial services than big corporates do?” And our conclusion was, “Because a market had evolved (called the bond market), which distanced mediated banks, which provided greater efficiency and provided big corporates with better values. Large companies don’t go to their bank to borrow money; they simply issue debt in the bond market. We wondered why that couldn’t happen on a consumer level as well. The data exists, but marketplaces depend on trusted third-party data, and there is a lot of really useful consumer data, which allows informing positions. We thought we could replicate the marketplace model, but for consumers.

Part of it is simply better modeling, better use of data, and some use of alternative data. We still use most of the traditional credit industry data . . . but I think we buy more of it, and we use it more intelligently. We’ve also begun to use some sources of alternative data.

—Giles Andrews, CEO, Zopa

Brett: On the matter of the lending model you’ve got, one of the things you and I have talked about in the past is how you assess risk. One of the things I’ve always been fascinated by is your robustness from a default perspective. After all, you’re one of the best-performing institutions in the U.K. market, in respect to defaults in nonperforming loans.

Giles: And I think we’ve gotten better since we last spoke, Brett. We have the best-performing loan book in the United Kingdom. We have had default rates of below .8 percent in the last eight years. If you put that into context on an annualized basis, that means that credit losses are well below half a percent a year. And that plays against banks that are somewhere between 3 and 5 percent a year. We are in fact better (in terms of our default performance). I think part of that is from building credit models at a time when the world was increasingly over-indebted and worrying a lot about affordability, which might sound obvious now, in 2013, given the crisis we’ve been through. But in 2005, it didn’t seem obvious—certainly not to banks that were still lending money to people on the basis of their previous track record without really wondering whether the loans were sustainable. Part of it is having the good fortune of building a credit model at a time when it was obvious to us that there was a problem looming.

We were not clever enough to see the subprime crisis that evolved two or three years later. But, we certainly did see that consumers were over-indebted. Part of it is simply better modeling, better use of data, and some use of alternative data. We still use most of the traditional credit industry data, and we still find that by and large to be the most predictive, so we are using similar data to banks. But I think we buy more of it, and we use it more intelligently. We have also begun to use some sources of alternative data. The other part of it is that with a peer-to-peer model, the fact that people borrow money from other people seems to make them behave better in that relative circle of influence. There’s some evidence that consumers prioritize our debts, in some cases, over others because there are other humans at the end of the loans.

Brett: Very interesting psychology! So Giles, essentially, Zopa sounds like a social network in respect to the way it operates—a community of borrowers and lenders that you bring together. How much does the nature of social networking and community building factor into the success of Zopa from a business perspective?

Giles: It is really important to us to have an active community of engaged lenders. It might sound funny, but the community is really helpful as a sort of customer service tool. People actually respond really well to being given information by other customers. Often, they respond better to that than if it were given from the company itself. Putting all of your customer communications into discussion forums that live inside your website, on Twitter feeds, and on Facebook and things like that, and being prepared to share your customer service queries, says a lot about the transparency of your business and the fact that it is happy to have its dirty linen aired in public.

That is critical in the way the community has been a trust-builder. I think it would be fantastic to be able to leverage other peoples’ social networks as a customer recruitment tool. We haven’t really found any evidence of that happening. My conclusion is that people don’t really want to talk about money via social networks. They’re called social networks for a reason; they’re not business networks.

Brett: You mean they’re not going to share on Twitter, “Whoo-hoo! I just took a Zopa loan!”?

Giles: “That shiny car outside, I actually borrowed money to buy it.” No, they are less likely to talk about that. Lenders are happier to talk about it because they feel that they are doing something clever. They are happy to share their insights on that and (beneficially for us) they are even happier to share their insights with other people.

Brett: Even with a good credit history, a good credit rating, doing all the right things in a tough economy, it is hard to lend money. Giles, are you guys going to be the knight on the white horse who comes in and just totally fixes the credit industry and maybe replaces the banks in terms of things like personal loans and debt consolidation?

Giles: I can think of two reasons why we will not replace banks. First, Zopa (and I could say the same about the peer-to-peer lending businesses in the United States) does not operate typically as a lender of last resort. Typically, we do not lend money to people who otherwise would not get finance. Second, we do use the data that banks use to analyze whether they should lend people money more intelligently. If you do qualify for a loan, you’ll get a loan that’s much cheaper. I think the challenge for anyone lending money is using the data intelligently and being able to form a view of individuals that they not only have the wherewithal to repay the money, but also their previous track record has demonstrated an aptitude toward repaying money.

Brett: Banks are selective about when they choose to take the story behind a person’s credit history into consideration.

Giles: And they have capital constraints. It is very difficult for me sitting in London to pass direct comment on that, but I can go on to the more general question about where we and businesses like us go.

By focusing on a narrow sector of banking, Zopa and other peer-to-peer lending businesses are not looking to replace banks in their entirety; we are looking to do a slice of banking more efficiently and better. By offering personal loans, which have a repayment history, we can create an opposite result, appealing to savers. The loan begets the saving product, because we can offer a predictable return over the long term. It doesn’t mean we can easily offer credit cards and current accounts, because we couldn’t finance a balance that was going up and down, and our lenders demand regular and fixed rates of return. But, within the savings and loan industry, we can take a dramatic piece of banking away. And I think it’s a piece of banking that they are particularly bothered about. Banks are more interested in their core products, providing mortgages, current accounts, and perhaps doing some big-company business lending, than they are in lending smaller amounts of money to consumers to buy cars.

Brett: Getting into this issue of being a “bank replacement,” one of the aspects you mentioned is your saving rates are better and your loan rates are lower. How do you do that, given the traditional model of lending? How do you make money? Where’s the margin?

Giles: The simple answer is that we are extremely efficient. We’re an online direct business without overhead and big branches and all that kind of stuff. The business model is simply more efficient. A way to think about it is to say that banks have a spread and that the bank spread is the difference between what they pay their savers and the cost of the money that they bring in. What they charge their borrowers is the income that they generate from their savings. Bank spreads in the United Kingdom are over 10 percent now. They’re wider than they have been in living memory. And my guess is that they are pretty similar in the United States.

Our model replaces the bank spread with our fees and the bad debts that result from the loan book. If you add all that together, in our case, the equivalent spread for us is about 3 percent. Three percent replaces the typical bank’s 10 percent. It’s a good deal.

Brett: That’s still a pretty good margin.

Giles: And we can make money at those 3-percent-fee levels.

I’ll talk about what we can learn from P2P and the approach of neo-lenders like Zopa, Lending Club, and Prosper shortly. Now, let’s focus on a completely different approach to credit risk assessment.

A DIFFERENT TYPE OF CREDIT ASSESSMENT BASED ON COMMUNITY

In Bank 3.0, I wrote about the psychology of banking in the U.S. market, where there are more chartered banks than in any other country anywhere in the world. Part of the reason for the broad acceptance of the community banking model was the view that large banks, what we’d call the too-big-to-fail banks today, were essentially “foreign models” of banking.

In the 1930s and 1940s in the United States, for example, there was broad industry condemnation of “branch banking” as it pertained to the destruction of individualism and community banking practices in favor of cookie-cutter branch banking approaches built on efficiency, sales, and transaction banking. These so-called “foreign systems” of branch banking were labeled “monopolistic, undemocratic and with tinges of fascism” and as “a destroyer of individualism.”22This also explains why the United States has so very many institutions compared with other developed economies, as U.S. regulators historically sought to institutionalize community support and make it harder for monopoly approaches.

—Bank 3.0, Chapter 4, “Can the Branch Be Saved?”

Historically, one of the real advantages of community banking was the ability of the community banker, who actually knew your name and your family, to make a qualitative assessment on your risk-worthiness. This type of personalized model of banking is hard to beat, but these days, realistically, this type of service and customer connection is extremely rare.

As banks grew and as branch managers had less and less autonomy, the ability to assess risk was optimized down to a set of algorithms and rules, a black-box credit risk model where they turn the handle based on a data set—and the black-box spits out a result—approved or declined.

As we get richer data sets and richer understanding on consumer behavior, what we’re going to see is more of a return to the type of data that a community banker would have instinctively drawn upon in making a credit decision locally, but applied in smarter decision matrixes. In that respect, drawing upon community is going to be one of the ways institutions can reduce risk. If your friends are willing to vouch for you, that should count for something, shouldn’t it?

That is in part what is behind the innovative approach to lending that Lenddo uses in both acquiring and assessing new customers. To find out more, I talked to Jeff Stewart, CEO of Lenddo, about their approach to credit assessment and microfinance.

Brett: Jeff, you are based in the United States, in New York, but most of your business occurs outside of the United States. Tell us a little bit more about Lenddo, how you started the business, where you are doing your lending, and what is the basis of the business.

Jeff: Lenddo helps people prove their identity and trustworthiness so that they can access financial services in emerging markets. We got into this business because we had started several companies and we had employees all over the world, and they kept asking us for loans, which didn’t make a lot of sense to us because we tend to hire people who are very employable, very hardworking. And they just kept asking for loans. So, as we dug into this issue, we discovered that there are about 1.2 billion people moving into the emerging market middle class who are generally underappreciated by the local financial institutions, and underbanked. We figured this seemed like something we should be able to fix.

As we dug deeper, we stumbled over something that changed our lives, which would be the concept of microfinance. And what really grabbed our attention with microfinance, which targets a different group at the bottom of the pyramid, was that microfinance had figured out how to involve the community so that people repaid. The community benefited from the repayment, and the whole process was just incredibly efficient.

We spent the better part of a year interviewing experts in microfinance—behavioral economists and anthropologists—to really understand the magic of microfinance and why was it so successful. What we learned was that we could duplicate this online. The entire hypothesis behind Lenddo23 is that you don’t have just Internet friends; your online social footprint represents a real social graph, a physical/real social network. And just like you can use microfinance at the bottom of the pyramid to create a social environment where you’re very efficient in deploying capital, you can replicate that for the middle class and empower them to access financial services at a lower cost.

Brett: The conventional wisdom might be, if you asked me as a banker, how I would feel lending in an emerging market, I would feel pretty tentative, saying, “Well, these are low-income people, there’s not much margin in it, and it’s likely to be very risky.” But, what are you telling me about the way you handle risk and default rates? Are you saying that you have quite low risks and low default rates because of the community element, specifically how you use intelligence from social networks?

Jeff: We have very low default rates because of the community element, but also because of whom we are lending to. This demographic is the future of the planet. This is the emerging-market middle class. This is where most of the wealth on the planet is being created.

To put it in perspective, in the Philippines, where we launched first over two years ago, the unemployment rate among business process outsourcing employees, or call center workers, was zero percent. You literally can walk outside and get another job across the street. These are college-educated people in white-collar jobs. Think about the people who are processing insurance claims, the people who are answering customer support calls for your Dell computers. They are very employable, and their incomes are rising. Our typical member makes between 400 and 450 dollars a month for white-collar employment; that’s up by double-digit percentages in the last year or two.

Brett: What’s the average loan size that you’re servicing?

Jeff: Our average loan in Asia is $450, and our average loan in Latin America is about $650.

Brett: It seems to correlate with a monthly salary.

Jeff: Exactly, although the loans are anywhere from 1 month to 6 or 12 months. We lend about a month’s pay.

Brett: Giles, let me ask you, what is the average loan size Zopa is doing in the United Kingdom, just to get some comparison with Lenddo here?

Giles: Just under 5,000 pounds.

Brett: Very interesting. Five thousand pounds is probably going to be pretty close to a monthly salary for a professional in the United Kingdom as well. It’s interesting that there’s a correlation with the emerging markets there on average loan size as it relates to monthly salary.

Jeff, how much of the lending you guys do is to small businesses trying to get started in these emerging markets?

Jeff: Our loans are for licensing purposes, so, education is the largest use. Access to smartphones is another big category. Access to healthcare is usually for other members of the family, not the actual borrower, say a sister or an aunt. That said, the group we’re lending to is very entrepreneurial. But what we are not doing is assessing the business itself.

If they are buying inventory when they are home with their family out in the countryside and then bringing it and selling it to their friends in the city, we don’t judge the business itself. We judge the character of the person. This gets back to how lending worked for thousands of years. It was based on the character of a person. It was based on their reputation in the community. And, in small business lending, you hit a threshold where, all of a sudden, the business model itself—the business plan—doesn’t matter a lot. But, as J. P. Morgan once pointed out when he was asked, “What’s more important, loan to asset or loan to income?” it is the character of the man. For any business the character of the man is important, but for small businesses, it really is everything.

I think where you see involving community in the underwriting process making a big impact is in the small business space. And you see it in microfinance, too.

Brett: What about in the United Kingdom, Giles? From your experience with Zopa, how many of your lenders are people who are trying to finance and start up a small business and are using Zopa as a platform for raising some financing?

Giles: Our lending base is quite keen to lend to small businesses, so we send out a questionnaire often because currently they are lending only to consumers; their response was that they were keen to lend to businesses because they felt it was worthwhile and useful.

We’re dipping our toes in the water because we are actually also working with the government as Funding Circle are, and we are launching a project to lend money to sole traders. We already lend to sole traders, but we don’t lend to them if they are seeking to use the money for their business. We would evaluate a sole trader—anything from a window cleaner, to a hairdresser, to a barrister—there are three-and-a-half million sole traders in the United Kingdom—and, if they applied for a loan for consumer purposes, we would assess them. We would look into their self-employment record in the same way we might look at someone’s employment record. But we would actually be declining them if they said they would want to invest the money in their business because we’ve found that added an extra level of risk.

Now we are working on launching a new product, which will be to sole traders for business purposes. The reason we are using sole traders is because we can put them through the same set of credit models as we do our existing consumers.

Brett: What I’m wondering, Giles, is in the United Kingdom you’ve probably seen the government has its “funding for lending” scheme where they are giving money to the banks to give to small businesses. But, of course, they’ve given the money to the bank, and the bank, broadly speaking, has just kept it. Could it be that peer-to-peer offers really a much more direct channel for government to stimulate the economy?

Giles: It absolutely could. They’ve made it clear that if we could make it work, then they’ll continue to fund it. I’ve heard the same from my friends at Funding Circle, that the government is there to support it. There is a degree of exasperation in their eyes that they know what is happening to money that they are giving to banks. It’s hardly being lent in residential mortgages. Or, it’s sitting, mending their balance sheets.

Brett: Jeff, How does this community mobilize in places like Indonesia, or the Philippines, where Facebook penetration is very high? How do you mobilize the community support element of this for Lenddo?

Jeff: It’s very simple. In order to get a loan, you need to have people in your community endorse you. What we found is that who, within your community, is willing to endorse you and what communities you’re a part of factor highly in predicting repayment. What happens is some of the people who help you join to get a loan end up wanting a loan also. It just keeps growing. We started with just 100 people whom we knew and trusted, and then that went to a thousand and then 10,000, and then a hundred thousand. It just keeps growing.

Brett: So it’s an acquisition channel as well, the community that you exist in.

Jeff: Absolutely! We were just talking with one of our customers, and he was saying how his friends didn’t believe that he had received money over the Internet, and that he couldn’t convince any of his friends to apply also. It wasn’t until their friends had three or four other friends who had a loan that they finally gave it a try. It just keeps on growing. Because it is a social product, and you have to have your friends on it to get any benefit out of it, we don’t see it slowing down any time soon.

THROUGH THE LOOKING GLASS: LENDING 3.0?

In looking at the business of lending, one key area that was covered with Jeff and Giles was how credit assessment and business models would emerge based on new data models and different views of risk and opportunity. Particularly, I wanted to look out a bit further, perhaps 5 to 10 years in the future, to see where this might go.

Brett: Just thinking about this business moving forward, we’ve taken the business of lending, and we’ve got a different look at risk, we’ve got different scoring and assessment systems, which appear to be very efficient with low default rates, and so on, and we’ve got community involvement that is being used for acquisition in the emerging markets.

Giles, where do you think this is going to go in 10 years’ time, as we continue to disrupt the way people borrow money, and even save money, because that’s sort of the vehicle we are seeing here as well? Where do you see the future of this business going and how you carve out a niche that sits on the side of the banking sector, and do you see that this becomes more of a viable alternative, particularly with less friction in lending, and how people have access to credit?

Giles: You’re exactly right to use the word niche. What’s so powerful about models like ours is that we take a small bit of banking and do it better. That allows us to be much more efficient and operate with much less friction, as you say. I can see businesses like ours, peer-to-peer lending, taking the majority of lending business from banks. I really mean that. We could take most of it from them. I think that that as a sort of example could happen in all sorts of bits of banking.

There are lots of silos of banking that aren’t really relevant to any other bit of banking, such as invoice discounting. Factoring is another example of a bit of banking that doesn’t really depend on any other type of banking. These new models could simply do it better. Banks have been struggling for many years with this inefficient model for parts of the business. The kind of stuff that you have been writing about in terms of disruptive change, they’ve struggled against for a long time. They are the last industry to be disrupted, but I think it’s finally happening now. And it’ll happen, not because a universal model will come along and do it better; it’ll happen because lots of small, nimble players will do little bits of it better. And they won’t be left with very much interesting.

Brett: Jeff, you’ve created a niche market with Lenddo because this is a market that wasn’t necessarily there before, or a segment that wasn’t being served. Where do you see this going over the next 10 years in terms of your own business, but also the business of lending money in the emerging markets?

Jeff: I agree this is all about change. I think you’re going to see software, and technology, and social networks essentially eliminate the traditional need for financial services. You’re going to see the industry reshaped similar to the way Napster reshaped music, or Skype reshaped telecommunications; and the reason is that the processing power, and the data, and the connectivity completely changed the dynamic.

There’s more processing power on your cell phone than probably most financial institutions in the world had in the mid-1980s.

—Jeff Stewart, Lenddo

You don’t need a big trust intermediary when your community can vouch for you. And they can with the click of a button. You don’t need a mainframe sitting in Citibank’s headquarters to process that and figure out what makes sense. There’s more processing power on your cell phone than probably most financial institutions in the world had in the mid-1980s. It’s just a completely different landscape, and I agree that it’s going to change.

I disagree, however, that it’s going to be a bunch of little players. I actually think that consumer finance is about twice the size of media in this country. And, when I say media, I’m talking about Facebook and Google and magazines and television. Consumer finance is bigger that all of that.

Brett: One of the things that stands out to me is if you look at a product like a personal loan, what you are really looking at is a tool that facilitates buying a car, buying a home, or perhaps starting a business. What banks have been able to do previously is stop someone from doing that activity until they jump through the application-form hoops and qualify for the specific lending facility or loan that enables this other activity.

With those tools you talked about, Jeff, the data analytics, the real-time capability, isn’t there going to be a tendency to reduce closing times, and that risk assessment, so that you can get a loan in real time, where you need it—exactly when you need it—rather than the loan having a distinct product “event” or separate application process in itself?

Wouldn’t it be more logical to embed the financing decision in the customer journey around those other things we do, like starting a business or buying a home?

Jeff: Absolutely. I think that what technology enables you to do is quantify your trustworthiness (in real time), and use credit and other financial services as needed. This is what’s right for the consumer, not what’s right for the lending institution.

Giles: I think Jeff’s exactly right. It’s all about the consumer. So, the financial institutions haven’t thought about the consumer; and what businesses like ours do is put the consumer first. We’ll build the experience the consumer wants, and that may be real time or it may not. That’s not the issue. The issue is doing it on the consumer’s terms.

THE KEY LESSONS

Despite the fact that Zopa and Lenddo are two very different businesses, there are some reoccurring themes in the messages we heard in these interviews.

First, to be better at the business of lending, the trick is not necessarily to do it the way banks are doing it.

Both Zopa and Lenddo show that they are both more efficient at their core business than comparable banks, and that their risk of default is generally lower. While they work at lower margins than the big financial institutions, their dramatically lower cost base, lower cost of acquisition, lower costs of distribution, and more accurate risk assessment models mean that banks can’t compete on the same basis.

A new generation of lenders is doing it better, cheaper, and safer than the guys who, theoretically at least, invented commercial lending.

Second, both Zopa and Lenddo started with a customer problem that needed solving, rather than what lending business are we building, or what products should we offer?

The problem with lending today, both from a risk assessment process and from a customer engagement perspective, is that the lending event, particularly in respect to the application process, is abrasive. Customers in general aren’t having a fun time with the whole process of credit, but they need credit to facilitate their life, whether it is buying a home or a car, or the credit card on that overseas trip.