New Market Paradigm Gives Rise to Non-Bank Lenders

In August 2012,
Vikram Pandit
, then chief executive (CEO) of Citigroup, denounced the notion of a bank as a ‘financial supermarket’ – that is as a place where many investors, risk managers, counterparties and depositors could all do business. This pronouncement came but 13 short years in the US after the Gramm-Leach-Bliley Act formally repealed two of the most restrictive parts of Glass-Steagall, the landmark rules from 1933 limiting affiliations between commercial banks, insurers and securities businesses.  

In the decade-long run-up to the most recent financial crisis of 2008, banks in both the US and Europe had gotten involved in businesses far beyond taking deposits and making loans, and some of those activities – when certain markets collapsed – imperilled the banking system.  In line with this statement, most banks have pulled back from many securities and lending activities over the past five years.

Small Business Struggles


Interestingly, from a consumer’s or a small business’ perspective, banks haven’t been supermarkets for a very long time. Gone are the days when a local branch would cover all financial and investment needs, ranging from savings and checking accounts to real estate loans, to consumer revolver credit, to student loans or business loans. Rather than a supermarket, most bank branches were (and are) more like a friendly corner store – somewhere you can go to meet a very limited set of needs – opening a deposit account, doing things with cheques and bill-pay, getting a real estate loan and others.

Competition and regulation have driven a wave of consolidation and centralisation into the banking system, and made costly restrictions on what sorts of activities banks can pursue. If you were to go and talk with someone who runs a commercial bank, chances are they’d tell you they simply can’t spend money on smaller and/or more bespoke loans. This is not because of credit losses, but simply because the costs associated with originating, underwriting, and holding the loan (including justifying the loan’s existence to that bank’s regulator worried about the safety of that bank’s deposits) are too high for them to make money doing smaller loans (sub-US$1m loans, as a rough guideline).  

Some banks do have ‘small business’ loan portfolios, but the
vast majority
of these ‘loans’ are actually small business credit card draw-downs. It’s hard to run a business on credit card debt alone.

Enter Non-Bank Lenders

In almost every loan type and asset class, we are experiencing a tremendous growth in non-bank lenders. In the middle market commercial space, business development companies (BDCs) have accumulated
US$40bn in assets
as of November 2013, according to the
New York Times
.

Private equity and hedge funds are springing up to serve a wide range of formerly ‘banked’ markets. Additionally, in the consumer and small business lending world, marketplaces have emerged to help bring investment to small businesses and consumers seeking funding. Underlying this broader trend is an important shift: instead of using deposits to fund investments, such alternative platforms offer investors a new set of investable asset classes – the returns of which formerly accrued only to banks.

Unlike banks, alternative lending (including crowd-lending) platforms are being built to utilise new technology and data to help speed-up underwriting and generally create a better borrower experience and superior credit results. A better borrower experience – which includes more transparency and faster access to capital – means that alternative lenders can provide a viable alternative to what banks used to do, offering fairly priced loans under US$1m. Solutions like this one can be good for borrowers, for investors, and for society writ large, as they help capital get back to ‘smaller’ borrowers – the ones whose needs are not being met by the typical bank branch corner store.

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