Bankers may be facing a run for their money. Technology-based rivals have been proliferating around the world. These firms come in a variety of shapes and forms. Many offer the potential to cut out the middleman, allowing savers to funnel cash directly to companies or individuals – so-called social or peer-to-peer (P2P) lenders.
Some firms, such as Nutmeg, are starting to encroach on the area of wealth management – providing investment options with ultra-low fees. Meanwhile, Square Cash and Paym, among others, allow users to make payments via mobile phones or email.
Pales in comparison
“This is not something that traditional financial services firms can afford to ignore,” says Mark Calabria, a banking expert at the Cato Institute in Washington, DC. “It is not yet clear whether most new companies will simply fill in gaps left by older firms, collaborate with them or actually threaten them. But it’s no time for complacency.”Emerging lending models in numbers
Total amount the UK’s P2P lenders expect to lend this year
Amount Pebble Smartwatch raised from 69,000 donors
Number of businesses that together have borrowed £290m from Funding Circle in four years
Amount that a group of investors have ploughed into Nutmeg
Percentage Nutmeg charges on an investment of £500,000+
So far most of these new businesses pale in comparison to older financial institutions. The UK’s Peer-to-Peer Finance Association (P2PFA) estimates that the P2P lenders it represents will lend out £1bn this year. That compares with net lending by conventional banks of £5.8bn in the third quarter of 2013 alone, according to Bank of England data.
Yet absolute size tells only half the story. The pace of growth in new forms of lending is extremely fast, observes Sam Ridler, Executive Director of the P2PFA. “The figures are showing exponential growth and it looks like we’ll have double the lending we had last year,” she says.
The novelty, excitement and opportunity to earn competitive rates of return from this new form of lending appear to be driving this acceleration. “P2P lending is becoming more mainstream,” says Ridler. “The sector is now regulated by the FCA and the Government is committed to launching P2P ISAs to help people who want to put their money to work get better rates.”
The low interest rates on offer from traditional banks have added to the appeal of the relative newcomers to prospective borrowers. “We’ve been lending for nine years and our rates have consistently outperformed the banks, but they have gone up and down according to what is happening in the market,” says Jonathan Kramer, Zopa’s Sales Director. “In the last two years they have been at a very steady average 5%, well above inflation.
“In the near future, lending through Zopa will be included in ISAs, meaning tax-free lending up to £15,000 a year. This is going to be very attractive to a vast majority of the British population and will help P2P lending go mainstream. It will shake up the banks to be a bit more competitive.”
Crowdfunding, where many individuals can contribute small sums to help get a venture started, has also been growing fast. Online hubs such as Kickstarter have enabled firms to gather relatively large sums of money. Pebble Smartwatch, for example, raised $10m from 69,000 donors.
Calabria does not believe that this type of lending need unduly worry established banks. “Banks often find making modest loans to small businesses or individuals more trouble than it is worth, with very low margins,” he says. “Especially with loans to start-ups, this is borrowing that might not otherwise happen at all.” Calabria adds that funds that allow individuals to make payments rely on each side of a transaction having bank accounts. “Many of these services remain linked to the old financial system.”
Ridler also downplays the level of competition. “It’s not that we are stealing business from the banks,” she says. “Banks can’t be exposed to those sectors so we’re just picking up what they themselves can’t lend to because of the way they are organised. We’re bringing diversity to the market.”
Where competition is taking place, established financial institutions may have the option of collaborating with new tech peers. In June, for example, Santander made a pact with P2P lender Funding Circle, becoming the first mainstream bank to start referring customers to such a site. Since setting up shop four years ago, Funding Circle has enabled about 5,000 businesses to borrow £290m.
A similar collaboration has taken off between conventional asset manager Schroders and online wealth firm Nutmeg. This summer it was reported that Schroders had joined a group of investors that had ploughed £32m into Nutmeg. Again, the online service may not always compete directly with established firms.
Nick Hungerford, Founder and Chief Executive of Nutmeg, has emphasised that most wealth managers focus only on relatively affluent individuals with £250,000 and above to invest. By contrast, the minimum investment necessary to set up a Nutmeg account is £1,000.
That does not mean that standard wealth managers should not be worried, warns Hungerford. “Thirty years of research proves that 75% of active funds – or thereabouts – underperform, and not just because of fees,” he points out. “It is very obvious that trackers and low-cost funds are an increasingly attractive way to go.”
It is quite possible that even more wealthy individuals will be seduced away from traditional lending avenues by such low-cost offerings. While the average discretionary manager charges 1% to run a fund, Nutmeg has a sliding scale which sees it charge 0.3% on investments of £500,000 or more.
A bigger threat still is the notion that technology giants such as Google and Facebook will seek to muscle into the fund management industry. Such companies would have the ability to access millions of customers, especially those under 40 years old. Google especially has a record of diversifying its business offering.
Broadly speaking, the fintech sector, which according to an EY report is currently generating £20bn in revenue a year, comprises all technology that engages with or delivers financial services. Extending well beyond companies that deal directly with money, the sector includes everything from mobile payments and compliance to P2P lending and project management.
It can be split into two distinct groups:
1. the early innovators – businesses that provide software and services to financial services; and
2. B2P pioneers, those companies disrupting the market for lending and challenging traditional providers.
Stripe, Square and Mint are perhaps the best-known players, but a host of new start-ups, including WorldRemit, Moni Technologies, Azimo and TransferWise, are seeking to revolutionise the international money transfer market.
It is clear that digital innovators are slowly but surely changing the financial landscape. And while conventional firms might not be directly threatened, it would be a mistake for them to take their eyes off the ball.