The Route – Finance’s summer book launch was an exciting event – and not only because Richard Admiraal’s Be The Bank formed the centrepiece for discussion about how investors can earn high returns securely by lending to SMEs. For we were lucky enough to hear a talk from David Sayer, Global Head Of Banking at KPMG.
A key element of Mr Sayer’s role is to have regular discussions with major banks around the world, which gives him a very clear perspective on the different strategies being adopted in a very challenging environment. His professional profile is extensive and widespread. In the last two years he has met senior clients in Australia, Hong Kong, China, Singapore, Korea, Japan, Saudi Arabia, Abu Dhabi, Russia, the Eurozone, USA, Canada, Mexico, Chile and Brazil. Over the past 18 years he has been leading teams advising Banks on major transformation programmes. Needless to say, we were delighted to hear Mr Sayer’s views on the current state of the financial playing field around the globe, in particular how the major banks are positioning themselves against the barrage of alternative finance platforms that are charging the battleground at present.
A Challenging Environment For Banks
It’s no secret that in the current climate, traditional financial providers – i.e. the banks – are struggling to keep pace with the innovations that are emerging in the FinTech sector. Indeed, Mr Sayer was keen to point this out very early on in his speech.
“The Legacy platforms the banks have got have been very, very hard for them to change and use now with the technology. But there was a financial crisis, and that has meant virtually every bank’s business model has been destroyed. If you look at Europe, banks have just about fixed their balance sheets. They have raised capital […], their balance sheets are subject to IFRS accounting standards […], but in doing so their profit and loss accounts have been utterly destroyed.”
As we have reported in our news feed, one of the biggest challenges that banks all over the globe face is that they simply cannot keep up with the pace of technological change that organisations in the FinTech and AltFi sectors are built upon.
In addition, an equal challenge for the banking industry lies in the fact that banks are unable to lend money like they used to as a result of the regulations that have been imposed on them in the wake of the financial crisis. These regulations have been implemented to make banks “safer”, i.e. protected from collapse (and themselves), which is of course important while they still enjoy the dubious status of being “too big to fail”. But, as Sayer points out, what this actually does is hand a huge competitive advantage to the alternative finance industry.
“The banking business model is going to have to change fundamentally to give return on capital, which is something close to the cost of capital imbalance, which is around 14%. Banks are going to stop doing a large number of things they currently do, and it’s going to be harder to borrow from banks. Banks will be safer as a result, but what it really does with now-available technology [is] create a huge opening for alternative financing.”
Recalling discussions he’d had with FinTech investors in San Francisco earlier in the year, Sayer went on to note how profitable these investments can be right now – so much so, in fact, that a one in five success rate was considered to be an acceptable return by investors.
“No bank in the world earning a 4% return on equity can make investments in bets which have that rate of pay. It is a really challenging time to be a bank, [and] alternative finance has a large number of competitive advantages right now.”
So what are these competitive advantages? Sayer lists three key advantages that AltFi has over its competitors.
1. Lack of Legacy
Firstly, almost entirely without exception, alternative finance platforms don’t have outdated legacy systems to contend with. Indeed, if we were to scrap a couple of hundred years of financial history and were just inventing banking right now in the digital age, then we would probably have something that looks a lot like the alternative finance industry that is emerging today. It would be a marketplace that was hosted on the internet, where businesses would be brought together with investors with capital who would be looking to make a sizeable return. Loan data would be completely transparent, investors would know exactly who they are lending to, and would scrupulously perform due diligence to ensure that their investment was as safe as could be, and no one platform would be too big to fail.
“You use the internet,” says Sayer, “to bring together those who want an acceptable return on their deposits and will accept some significant risk in return for a higher return, which they feel is adequately explained to them.”
In the digital age, data is everything – and transparency is everything else. This is the only way of ensuring safety, integrity, and accountability in each and every financial operation that occurs. Alternative finance has the advantage in all of these areas – but high levels of care and thorough, diligent procedures must be maintained going forward to continue the ascendancy.
2. Lack Of Mistrust – Especially Amongst Millennials
Social media, of course, plays an absolute defining role in the digital age – as it does of millennials. Facebook, Twitter, LinkedIn – these are media that millennials live within. They know, trust and even breathe these platforms, and any 21st century alternative finance platform has been born into this world. The banks were not – and again this harks back to their outdated legacy systems, not least in their marketing efforts.
Indeed, Sayer recalled a recent workshop that he was running with a group of millennials:
“One of the key things that came across from that large group was they absolutely don’t trust advertising by mainstream companies at all. They absolutely trust word of mouth, and they trust word of mouth that proves itself to them, and they listen to a lot of people. They don’t just listen to a corporate message, and anything that looks like a corporate message they totally discount, and you look at the hundreds of millions an average bank spends on advertising, and you say – actually, if you’re really trying to address that market segment, you’ve got a competitive advantage because you haven’t got hundreds of millions of dead cost.”
AltFi platforms were born online, and so were millennials. Therefore, in order to attract and interest them, it is via online means of advertising – social media marketing, content marketing, hashtag marketing, etc. – that AltFi platforms must turn to. Companies in 2015 and beyond need to engage with their customers in a personal, social, and distinctly un-corporate way.
And indeed, this is already happening. Alternative finance understands the internet, simply because it is of the internet. And, as Sayer rightly points out, this puts the AltFi sector at an immediate advantage because it’s not throwing away hundreds of millions on advertising, which only serves to spread a culture of distrust amongst the new tech-savvy generation of entrepreneurs in any case.
3. Lack Of Regulation
“Much alternative finance […] is treated as a marketplace by regulators,” says Sayer. “It’s a much lighter touch for regulation. Now, quite how long the regulation stays light to touch is a really interesting question, but right now it’s a huge competitive advantage.”
Indeed it is, and it’s one that AltFi providers absolutely must try and capitalise on while the regulation is still so light.
Presently, the banks have been effectively hamstrung by the regulations that have been imposed upon them in the aftermath of the global financial crisis. And this has had a massive effect on the success of alternative finance.
A new market for finance has been created. The estimated rejection rate of SMEs looking for funding from their bank stands at approximately 50%. Many of these businesses are actually viable and creditworthy, but they are not meeting the risk profiles that the large banks are now being forced to insist upon. And it gets worse. Earlier this year draft legislation was put forward by the Basel Committee on Banking Supervision, which rules that banks will need to treble the amount of security needed for an SME to borrow money.
And so a demand for finance has been created – and the AltFi sector has been providing the supply. As Sayer notes, currently, the industry is still being treated as a marketplace like any other, and so at the moment regulation is light and unrestrictive.
In addition, and to further impinge upon banks’ attractiveness, interest rates have remained appallingly low since the collapse, and this has caused/forced many investors to look elsewhere for meaningful returns – and once again the AltFi sector is delivering.
“Alternative finance has a huge tailwind from QE [quantitative easing]. Interest rates are so low that people are willing to take some risk for some return, because they’re getting no return. Most banks, frankly, don’t know what to do with the deposits you’ve made – because their balance sheets are shrinking, and with ring-fencing they won’t be allowed to use those deposits to fund any form of investment banking. So even with QE going, as ring-fencing comes in, banks are going to find it really hard to pay a competitive rate on deposits.”
The time has never been more opportune for alternative finance – both as a borrower, and as a lender (and, by the same measures, the time has never been more problematic for banking). At present, while there’s still an absence of regulation, the industry has a real chance to go from strength to strength, and start to mount a meaningful, lasting, disruptive challenge on how finances are conducted in the mainstream. Self-regulation, of course, is still important – especially if the AltFi sector wishes to maintain and improve its consumer-trust, and continue to impress millennial entrepreneurs and protectors of the economy of the future. Alternative finance has the arsenal to do all of this, and more, so long as the key players all manage to leverage the current competitive advantages in their favour.
If this happens and operators remain smart, safe, and above all else diligent in their endeavours, then, as Sayer closes by saying, there really is an “intriguing possibility that alternative finance will be the most effective challenger to banks if we look forward over the next 30 years.”