When Lending Club emerged on the public market with its $1 billion IPO, industry analysts largely considered the smashing debut to be the event that legitimized alternative lending.
“Determining the best pricing for Lending Club’s IPO has been tricky because the company will be in a league of its own when it begins trading on the New York Stock Exchange,” The New York Times had written just ahead of the firm’s offering last year. Such a stellar performance – the December 2014 IPO valued the company at $10 billion at one point – propelled the alternative finance industry onto the mainstream market, and it began to be taken seriously.
But before Lending Club’s IPO, which was followed by other alternative lenders’ own successful debuts, the decision for former Treasury Secretary Lawrence Summers to join the company’s board suggested that some economists anticipated the rise of alternative lending before others.
Last week, Summers launched the Lend It 2015 conference with a keynote address that brought new vigor to the still-emerging industry.
“This is a moment of extraordinary potential for information technology innovation,” Summers declared, adding that it is now time for alternative financing to disrupt the financial sector’s status quo and stabilize the economy.
Summers’ speech centered largely around the innovators of our time and their ability to bring progress to all aspects of our lives. But what is strange, he said, is how technology has negated to disrupt the world’s mainstream finance, and that the most innovative tools have benefited money more than they have people and businesses.
All that, he said, is about to change.
“I believe that the traditional financial system, given its performance, is ripe for disruption,” Summers declared. “I believe that it is more than most sectors the moment for disruption, given success and informational technology, and I believe that the nature of the incipient disruption, the use of information technology to lend in new ways, is directly responsive to the problems that have caused such dissatisfaction with the financial system over the last generation.”
The economist’s own support of technological innovators bringing change to the financial system comes in his positions on the board of both Lending Club and Square, which recently unveiled its new small business lending service, Square Capital. Joining these firms, he said, is a manifestation of his belief that the application of innovative technological tools to the lending space has the potential to completely transform the market and remove much of the friction experienced by borrowers today.
One major source of that friction removed by alternative finance providers is the cost of mainstream banks’ intermediation in the process. But there are other benefits to the industry, too. Its use of Big Data, for example, will lead to more stable investments in borrowers. “The systematic use of data on a large scale will permit better credit judgments, and that will permit the more accurate allocation of capital,” Summers said. The use of data, through both existing sources as well as previously untapped ones, also means lenders will reach more qualified borrowers. “Those who are creditworthy, but have not yet been able to prove themselves to be creditworthy, will now be given opportunities to prove themselves to be creditworthy and enter the mainstream and see their borrowing costs decline over time,” he added.
Lending innovation also has the benefit of providing a more positive consumer experience. Collectively, these positive impacts of the alternative finance market can bring about major change to the nation’s economy as a whole, thanks to a more diverse financial ecosystem. “If we can have more resilience in the basic provision of credit through more diversity, we can have a more stable financial system,” Summers said.
Despite all of these apparent upsides to this emerging market, Summers acknowledged the necessity for regulation. The rules, however, should not interrupt the positive effects of the market, and, according to Summers, there are several principles that can guide the authorities in establishing alternative lending policy.
Regulators should “let new business models emerge,” for example, and work on the presumption of permission, not prohibition. Transparency will also be key to successful regulation of the market, Summers said. “Regulators should require full transparency and disclosure, and see how consumers react to new products and prices before writing the rules,” he said, adding that while he is not condoning a “laissez-faire” approach to market regulation, history has shown the exploitation of consumers by past financial innovations.
Third, Summers argued that authorities must “maintain a level playing field” when regulating the industry, meaning that the alternative players in the lending market should not be exempt from the existing regulatory principles that protect consumers. However, the market should not be required to adhere to inappropriate rules. For example, the requirement that banks must have their balance sheets monitored should not also apply to online platforms that connect lenders and borrowers, considering that these platforms do not have balance sheets.
Last, Summers declared that authorities must “provide workable regulatory frameworks.”
“To date, regulatory authorities have generally maintained appropriate attitudes towards innovative lenders,” he said. “It will be important as the industry evolves and grows that regulators not create overhangs of uncertainty or burden excessively those attempting to innovate.”
To date, the alternative lending sector has garnered excitement in the financial sector as a point of salvation for cash-strapped businesses in need of working capital yet encountering high interest rates and high rejection rates with their banks. But the sentiment among industry experts has largely been the kind of cautious optimism seen by The New York Times in its predictions for Lending Club’s IPO.
The market is young and without many precedents. But proper regulation through rules that do not restrict innovation, along with high-profile supporters like Lawrence Summers, may soon lead to the kind of success seen by Lending Club duplicated throughout the alternative finance sector.
We’re always on the lookout for opportunities to partner with innovators and disruptors.
Learn More