Fintech and Banking. Can We Reach Small Business Lending Utopia?

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1 Fintech and Banking Can We Reach Small Business Lending Utopia?

2 Fintech and Banking: Can We Reach Small Business Lending Utopia? Karen G. Mills Senior Fellow, Harvard Business School Former Administrator of the U.S. Small Business Administration; Member of President Obama s Cabinet Digital Lending Conference November 2, 2017

3 WORKED FOR PRESIDENT OBAMA AS HEAD OF SMALL BUSINESS ADMINISTRATION ( ) 97% 84% 3

4 FLYING ON AIR FORCE ONE 97% 84% 4

5 MEMBER OF PRESIDENT OBAMA S CABINET Responsible for America s small businesses and entrepreneurs 5

6 Quarterly Net Job Change (in 000s) SMALL FIRMS HIT HARDER IN THE CRISIS Job losses in small firms accounted for 60% of total job losses Small (<500 Employees) Medium ( Employees) Large (1000+ Employees) Source: Bureau of Labor Statistics, Business Dynamics Statistics (latest as of 2Q15). 6

7 Quarterly Net Job Change (in 000s) SMALL FIRMS HIT HARDER IN THE CRISIS Job losses in small firms accounted for 60% of total job losses Small (<500 Employees) Medium ( Employees) Large (1000+ Employees) Source: Bureau of Labor Statistics, Business Dynamics Statistics (latest as of 2Q15). 7

8 Loan Volume (in billions $) TURNAROUND IN SBA LENDING Swift action to spur SBA lending, resulted in record year in 11, 12, and 13 $35 $30 $25 97% 84% $30.5 $30.3 $30.1 $20 $25.0 $22.0 $18.0 $15 FY08 FY09 FY10 FY11 FY12 FY13 Source: Small Business Administration. 7(a) and 504 total of loans enabled since Fiscal Year As of May

9 WHY WORRY ABOUT ACCESS TO CREDIT FOR SMALL BUSINESSES? Small businesses account for half of U.S. jobs 30 Million Small Businesses Non-Employer ~24M Employer 5.8M Gig economy 97% 84% High-Growth ~.2M Suppliers ~1M Main Street ~4M Other ~.6M Venture-backed firms Source: Author s analysis of data from the U.S. Census Bureau. 9

10 HBS WORKING PAPER 2014 Small business marketplace lending 2016

11 CURRENT GAP IN SMALL BUSINESS LENDING: SMALL DOLLAR LOANS About 75% of small businesses want loans below $250K 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 76% 44% 15% 17% 13% 10% <50K $50-100K $ K $ K >$500K Source: Federal Reserve (New York), Small Business Credit Survey, Fall

12 SMALL FIRMS HAVE MORE TROUBLE GETTING LOANS Loan applicants receiving full funding versus those funded partially or not at all All Firms 50% 50% Over $10M 27% 73% $1M-$10M $100K-$10M 37% 55% 63% 97% 84% 45% Micro (<$100K) 63% 37% Financing Shortfall Fully Funded Source: 2015 Small Business Credit Survey, Federal Reserve, March

13 PHASE 1: EXPLOSION OF NEW FINTECH LENDERS PHASE 1 Online Lenders Enter Rapid emergence and growth of hundreds of new online lenders

14 TECHNOLOGY CHANGED THE GAME: NEW ONLINE LENDERS OFFER MANY SMALL BUSINESS PRODUCTS 97% 84% Source: Fundera Presentation. September

15 STRONG EARLY RESULTS: 21% OF APPLICANTS APPLY TO ONLINE LENDERS Percent of small businesses applying Small Bank 46% Large Bank 50% Online Lender 21% 97% 84% Credit Union 11% Source: 2016 Small Business Credit Survey: Report on Employer Firms, Federal Reserve, April

16 ONLINE LENDING: WILL DAVID SLAY GOLIATH?

17 BORROWERS LOVE THE EASE OF THE APPLICATION, BUT NOT THE HIGH INTEREST RATES Percent of borrower firms dissatisfied Application process difficult 26% 44% 42% Long wait for credit decisions 17% 44% 45% High interest rate 3% 6% 97% 84% 33% Large Bank Small Bank Online Lender Source: 2016 Small Business Credit Survey: Report on Employer Firms, Federal Reserve, April

18 ONLINE LENDING IS ENTERING PHASE 2 OF MARKET DEVELOPMENT PHASE 1 PHASE 2 Online Lenders Enter Partnerships Rapid emergence and growth of hundreds of new online lenders Partnerships between incumbents and online lenders

19 DON T COUNT OUT THE BANKS AND TRADITIONAL LENDERS Borrower Acquisition Borrower Experience & Satisfaction Customer/ Product Fit Cost of Funds Underwriting & Compliance Costs INCUMBENTS COMMUNITY BANKS DISRUPTORS 97% 84% 97% Source: Author s analysis and The Brave 100: The Battle of Supremacy in Small Business Lending. QED Investors and Oliver Wyman

20 DON T COUNT OUT THE BANKS AND TRADITIONAL LENDERS Borrower Acquisition Borrower Experience & Satisfaction Customer/ Product Fit Cost of Funds Underwriting & Compliance Costs INCUMBENTS COMMUNITY BANKS DISRUPTORS 97% 84% Source: Author s analysis and The Brave 100: The Battle of Supremacy in Small Business Lending. QED Investors and Oliver Wyman

21 DON T COUNT OUT THE BANKS AND TRADITIONAL LENDERS Borrower Acquisition Borrower Experience & Satisfaction Customer/ Product Fit Cost of Funds Underwriting & Compliance Costs INCUMBENTS COMMUNITY BANKS DISRUPTORS 97% 84% 97% Source: Author s analysis and The Brave 100: The Battle of Supremacy in Small Business Lending. QED Investors and Oliver Wyman

22 DON T COUNT OUT THE BANKS AND TRADITIONAL LENDERS INCUMBENTS Borrower Acquisition Borrower Experience & Satisfaction? Customer/ Product Fit Cost of Funds Underwriting & Compliance Costs COMMUNITY BANKS DISRUPTORS? 97% 84% Source: Author s analysis and The Brave 100: The Battle of Supremacy in Small Business Lending. QED Investors and Oliver Wyman

23 DON T COUNT OUT THE BANKS AND TRADITIONAL LENDERS INCUMBENTS Borrower Acquisition Borrower Experience & Satisfaction Customer/ Product Fit Cost of Funds? Underwriting & Compliance Costs COMMUNITY BANKS DISRUPTORS? 97% 97% 84% Source: Author s analysis and The Brave 100: The Battle of Supremacy in Small Business Lending. QED Investors and Oliver Wyman

Underwriting & Compliance Costs COMMUNITY BANKS DISRUPTORS 97% 84%?

24 DON T COUNT OUT THE BANKS AND TRADITIONAL LENDERS INCUMBENTS Borrower Acquisition Borrower Experience & Satisfaction Customer/ Product Fit Cost of Funds? Underwriting & Compliance Costs COMMUNITY BANKS DISRUPTORS 97% 84%? 97% Source: Author s analysis and The Brave 100: The Battle of Supremacy in Small Business Lending. QED Investors and Oliver Wyman

25 BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES High Level of Integration Low 97% 84% Source: Author s analysis. Low Investment of Time & Money Required High 25

26 BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES Arms-Length Strategy High Level of Integration Low Refer Declines 97% 84% Buy Loans Source: Author s analysis. Low Investment of Time & Money Required High 26

27 BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES Offer Bank Products On Online Marketplaces Arms-Length Strategy Partnership Strategy High Level of Integration Utilize Alternative Lender s Technology To Power Online Application White Label Online Application, Underwriting, Servicing Low Refer Declines 97% 84% Buy Loans Source: Author s analysis. Low Investment of Time & Money Required High 27

28 BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES Offer Bank Products On Online Marketplaces Acquire Online Player Arms-Length Strategy Partnership Strategy High Level of Integration Utilize Alternative Lender s Technology To Power Online Application Build Own Product White Label Online Application, Underwriting, Servicing Build or Buy Strategy Low Refer Declines 97% 84% Buy Loans Source: Author s analysis. Low Investment of Time & Money Required High 28

29 BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES Offer Bank Products On Online Marketplaces Acquire Online Player Arms-Length Strategy Partnership Strategy High Level of Integration Utilize Alternative Lender s Technology To Power Online Application Build Own Product White Label Online Application, Underwriting, Servicing Build or Buy Strategy Long-Tail Strategy Low Refer Declines Direct Equity Investments 97% 84% Buy Loans Internal Innovation Incubator Source: Author s analysis. Low Investment of Time & Money Required High 29

30 INNOVATION INSIDE BANKS: CASE EXAMPLE Eastern Bank Eastern Labs 1.0 Numerated 200 year old mutual bank Top SBA lender in New England Legacy systems We should worry about people putting us out of business, but we should also put ourselves out of business. Bob Rivers, Eastern Bank CEO Labs received 1% of annual gross revenues Worked from glass box in lobby Numerated spinout in May 2017 Eastern 25% ownership Top-tier investors FIS Venrock 97% 84% Success for Eastern? Sources:

31 PHASE 3: WHO WILL BE THE WINNERS? PHASE 1 PHASE 2 PHASE 3 Online Lenders Enter Partnerships Selected Winners Emerge Rapid emergence and growth of hundreds of new online lenders Partnerships between incumbents and online lenders???

32 PLATFORM PLAYERS ENTERING Platforms like Amazon have accelerated their lending volumes Players to watch Loans through Amazon Lending ($ billion) Paypal Alibaba Square Amazon AmEx 97% Amazon Lending Statistics 20,000 small businesses $3 billion total loans $1,000 to $750, % interest rates Sources: Beyond Fintech: A Pragmatic Assessment Of Disruptive Potential In Financial Services. World Economic Forum. August and Thurbon, Rob. Amazon has lent over $3 billion to merchants since TechSpot. June 12,

33 PHASE 4: SMALL BUSINESS UTOPIA PHASE 1 PHASE 2 PHASE 3 PHASE 4 Online Lenders Enter Partnerships Selected Winners Emerge Small Business Lending Utopia Rapid emergence and growth of hundreds of new online lenders Partnerships between incumbents and online lenders??? Affordable pricing and high customer service

34 WHAT ROLE WILL REGULATION PLAY? National Credit Union Administration Federal Reserve Federal Deposit Insurance Corporation Office of the Comptroller of the Currency Office of the Comptroller of the Currency Consumer Financial Protection Bureau Securities and Exchange Commission

35 CURRENT STATE: SPAGHETTI SOUP MULTIPLE REGULATORS Currently little oversight of small business online lenders Federal Reserve Federal Regulators State Regulators FDIC OCC NCUA FTC CFPB SEC Banking Securities Depository institutions Non-depository entities that offer consumer financial products or services 97%? Small business online lenders Broker-dealers or other securities and derivatives markets intermediaries Safety and soundness oversight FDIC: Federal Deposit Insurance Corporation Consolidated supervision or systemic risk-related oversight OCC: Office of the Comptroller of the Currency Borrower financial protection oversight NCUA: National Credit Union Administration Securities and derivatives markets oversight FTC: Federal Trade Commission Financial Stability Oversight Council member agency CFPB: Consumer Financial Protection Bureau SEC: Securities and Exchange Commission Source: Author s analysis and GAO , Financial Regulation: Complex and Fragmented Structure Could Be Streamlined to Improve Effectiveness, March

36 REGULATORY QUESTIONS 1. Who should get a non-bank charter? 2. How can we make sure bad actors do not hurt small businesses? 3. How can we improve third-party guidance to allow for partnerships? 4. How can we collect data on small business loan originations without creating undue burden? 97% 84% 36

37 ONE GUIDING PRINCIPLE: DO IT SMART Small business lending is at the intersection of FinTech, GovTech, and RegTech RegTech FinTech Small business marketplace lending Small business marketplace lending GovTech 1. Issue clear, succinct, joint guidance 2. Engage industry 97% 84% 3. Use technology 4. Be data driven 37

38 WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE? TRADITIONAL Banks Credit Unions

39 WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE? TRADITIONAL Banks Credit Unions Disruption by: - Technology - Entrepreneurship DISTRUPTORS

40 WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE? REGULATORS National Credit Union Administration Federal Reserve Federal Deposit Insurance Corporation Office of the Comptroller of the Currency Office of the Comptroller of the Currency Consumer Financial Protection Bureau Securities and Exchange Commission TRADITIONAL Banks Credit Unions Disruption by: - Technology - Entrepreneurship DISTRUPTORS

41 WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE? REGULATORS National Credit Union Administration Federal Reserve Federal Deposit Insurance Corporation Office of the Comptroller of the Currency Office of the Comptroller of the Currency Consumer Financial Protection Bureau Securities and Exchange Commission? TRADITIONAL Banks Credit Unions Disruption by: - Technology - Entrepreneurship DISTRUPTORS

42 WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE? REGULATORS? WHITE HOUSE National Credit Union Administration Federal Reserve Federal Deposit Insurance Corporation Office of the Comptroller of the Currency Office of the Comptroller of the Currency Consumer Financial Protection Bureau Securities and Exchange Commission? TRADITIONAL Banks Credit Unions Disruption by: - Technology - Entrepreneurship DISTRUPTORS

Federal Deposit Insurance Corporation Office of the Comptroller of the

Protection Bureau Securities and Exchange Commission?

43 WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE? REGULATORS? WHITE HOUSE National Credit Union Administration Federal Reserve Federal Deposit Insurance Corporation Office of the Comptroller of the Currency Office of the Comptroller of the Currency Consumer Financial Protection Bureau Securities and Exchange Commission?? TRADITIONAL Disruption by: - Technology - Entrepreneurship DISTRUPTORS CONGRESS Banks Credit Unions

44 SMALL BUSINESS OWNERS

WEBINAR: THE IMPACT OF PREDATORY LENDING ON SMALL BUSINESSES. National Week of Action January 27, 2016

WEBINAR: THE IMPACT OF PREDATORY LENDING ON SMALL BUSINESSES National Week of Action January 27, 2016 Introduction Joyce Klein Director Caitlin McShane, Director of Marketing and Communication Mary Fran