Andrew Graham is co-founder and chief executive officer of Borrowell, a Toronto-based online lender that offers personal loans.
For consumers, choice is good. In financial services, Canadians have very little of it. Our six largest banks enjoy more than 85 per cent market share. Our banking system has proven to be stable but expensive, with some of the highest per capita banking profits in the world. Against this backdrop, the rise of innovative new financial services companies, powered by technology and focused on customer service, is exciting.
Online marketplace lenders, which make loans online with funds provided by investors, are already giving borrowers responsible alternatives to credit card debt. Globally, the industry is growing at an astonishing pace. Lending Club, the largest such firm in the United States, is making nearly $1-billion (U.S.) a month in new personal loans, and is more than doubling new loan volumes every year. Most of its borrowers use the money to refinance higher-cost debt. In small business lending, the story is similar. As large banks pulled back, marketplace lenders in the United Kingdom, the United States and now in Canada have moved to fill the gap. With $82-billion (Canadian) of credit card debt outstanding in Canada, there are great savings to be had.
Should we be excited or worried by the rise of technology-driven lenders? Critics, such as chartered professional accountant Talib Contractor, who wrote in this space last week (How 'Fintech' Lending Could Fuel More Bankruptcies – Dec. 11), raise three concerns: lax underwriting standards, lack of regulation, and systemic risk that could contribute to a future financial crisis.
None of these criticisms stands up to scrutiny. Consider underwriting standards first. Mr. Contractor and others say that the speed with which online lenders can approve an applicant is a sign of low standards, versus banks that might take weeks to process a loan. Successful technology-enabled lenders take a rigorous approach, looking at thousands of data points when evaluating a loan, but do it more efficiently – and much faster – by automating the process. In 2015, you should be able to get a personalized quote on a low-interest loan in a minute, online – and not have to spend days or weeks making trips to a bank branch. Technology can make the experience far better without taking short cuts, and cost savings are passed on to the consumer.
Second, online lenders are regulated. They are subject to a panoply of consumer lending regulation, and have to obey securities laws. They are very appropriately not regulated as deposit-taking institutions because they are not banks and don't take deposits.
Finally, marketplace lenders lessen, rather than increase, systemic risk in the financial system. To understand how, examine what systemic risk in financial services looks like: a system so interconnected that a failure at one institution risks bringing down the others; institutions being so similar that they react to events the same way, with amplifying effects; and bank runs, where a large number of customers withdraw cash from a bank at the same time.
Marketplace lenders reduce systemic risk on all three fronts. Funding comes directly from institutional investors, rather than being intertwined with traditional banking channels. A diverse set of sophisticated investors is less susceptible to a herd mentality than a highly concentrated banking system. Marketplace lenders also do not take deposits, so are not vulnerable to a run. By being different, they actually reduce the amount of systemic risk.
The underlying point is simple – the model brings a dose of diversity to Canada's finance sector. And diversity is key to the health of an ecosystem. Lawrence Summers, the former U.S. Secretary of the Treasury, has consistently made this point, arguing that marketplace lending "doesn't have the central connection to leverage that traditional banking does. There is no entity that carries a balance sheet with leverage. There's nothing there that is too big to fail. … And better information technology and better credit decisions mean less risk of failure and that, too, is a contributor to stability."
So let's cheer, not fear, the rise of customer-focused and technology-enabled lenders. Not only do they offer consumers more choice in an industry starved for it, they make our financial system stronger too.