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Fintech and Banking

Can We Reach Small Business Lending Utopia?

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

WORKED FOR PRESIDENT OBAMA AS HEAD OF SMALL BUSINESS ADMINISTRATION (2009-2013)

3

97% 84%

FLYING ON AIR FORCE ONE

4

97% 84%

MEMBER OF PRESIDENT OBAMA’S CABINET

5

Responsible for America’s small businesses and entrepreneurs

SMALL FIRMS HIT HARDER IN THE CRISIS

6

Job losses in small firms accounted for 60% of total job losses

Source: Bureau of Labor Statistics, Business Dynamics Statistics (latest as of 2Q15).

-2000

-1500

-1000

-500

0

500

1000

1500

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Qu

arte

rly

Net

Jo

b C

han

ge (

in 0

00

s)

Small (<500 Employees) Medium (500-999 Employees) Large (1000+ Employees)

SMALL FIRMS HIT HARDER IN THE CRISIS

7

Job losses in small firms accounted for 60% of total job losses

Source: Bureau of Labor Statistics, Business Dynamics Statistics (latest as of 2Q15).

-2000

-1500

-1000

-500

0

500

1000

1500

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Qu

arte

rly

Net

Jo

b C

han

ge (

in 0

00

s)

Small (<500 Employees) Medium (500-999 Employees) Large (1000+ Employees)

TURNAROUND IN SBA LENDING

8

97% 84%

Swift action to spur SBA lending, resulted in record year in ’11, ’12, and ‘13

$25.0

$18.0

$22.0

$30.5 $30.3 $30.1

$15

$20

$25

$30

$35

FY08 FY09 FY10 FY11 FY12 FY13

Lo

an

Vo

lum

e (

in b

illio

ns $

)

Source: Small Business Administration. 7(a) and 504 total of loans enabled since Fiscal Year 2008. As of May 2014

9

97% 84%

30 Million Small Businesses

High-Growth

~.2M

Suppliers

~1M

Main Street

~4M

Non-Employer

~24M

Employer

5.8M

Other

~.6M

Source: Author’s analysis of data from the U.S. Census Bureau.

WHY WORRY ABOUT ACCESS TO CREDIT FOR SMALL BUSINESSES?

Small businesses account for half of U.S. jobs

Gig economy

Venture-backed firms

HBS WORKING PAPER

Small

business

marketplace

lending

20162014

CURRENT GAP IN SMALL BUSINESS LENDING: SMALL DOLLAR LOANS

44%

15% 17%

10%13%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

<50K $50-100K $100-250K $250-500K >$500K

11

About 75% of small businesses want loans below $250K

Source: Federal Reserve (New York), “Small Business Credit Survey”, Fall 2013

76%

SMALL FIRMS HAVE MORE TROUBLE GETTING LOANS

12

97% 84%

Source: “2015 Small Business Credit Survey,” Federal Reserve, March 2016.

63%

55%

37%

27%

50%

37%

45%

63%

73%

50%

Micro (<$100K)

$100K-$10M

$1M-$10M

Over $10M

All Firms

Financing Shortfall Fully Funded

Loan applicants receiving full funding versus those funded partially or not at all

PHASE 1: EXPLOSION OF NEW FINTECH LENDERS

PHASE 1

• Rapid emergence

and growth of

hundreds of new

online lenders

Online Lenders

Enter

TECHNOLOGY CHANGED THE GAME: NEW ONLINE LENDERS OFFER MANY SMALL BUSINESS PRODUCTS

14

97% 84%

Source: Fundera Presentation. September 2016.

STRONG EARLY RESULTS: 21% OF APPLICANTS APPLY TO ONLINE LENDERS

15

97% 84%

Source: “2016 Small Business Credit Survey: Report on Employer Firms,” Federal Reserve, April 2017.

11%

21%

50%

46%

Credit Union

Online Lender

Large Bank

Small Bank

Percent of small businesses applying

ONLINE LENDING: WILL DAVID SLAY GOLIATH?

BORROWERS LOVE THE EASE OF THE APPLICATION, BUT NOT THE HIGH INTEREST RATES

17

97% 84%

33%

17%

26%

3%

45%

42%

6%

44%

44%

Large Bank Small Bank Online Lender

Application

process difficult

Long wait for

credit decisions

High interest rate

Percent of borrower firms dissatisfied

Source: “2016 Small Business Credit Survey: Report on Employer Firms,” Federal Reserve, April 2017.

ONLINE LENDING IS ENTERING PHASE 2 OF MARKET DEVELOPMENT

PHASE 1 PHASE 2

• Rapid emergence

and growth of

hundreds of new

online lenders

• Partnerships

between

incumbents and

online lenders

Online Lenders

EnterPartnerships

DON’T COUNT OUT THE BANKS AND TRADITIONAL LENDERS

19

97% 84%

Source: Author’s analysis and “The Brave 100: The Battle of Supremacy in Small Business Lending.” QED Investors and Oliver Wyman. 2015.

97%

Borrower

Acquisition

Borrower

Experience &

Satisfaction

Customer/

Product FitCost of Funds

Underwriting &

Compliance

Costs

INCUMBENTS

DISRUPTORS

COMMUNITY BANKS

DON’T COUNT OUT THE BANKS AND TRADITIONAL LENDERS

20

97% 84%

Source: Author’s analysis and “The Brave 100: The Battle of Supremacy in Small Business Lending.” QED Investors and Oliver Wyman. 2015.

Borrower

Acquisition

Borrower

Experience &

Satisfaction

Customer/

Product FitCost of Funds

Underwriting &

Compliance

Costs

✔

✖

INCUMBENTS

DISRUPTORS

COMMUNITY BANKS

DON’T COUNT OUT THE BANKS AND TRADITIONAL LENDERS

21

97% 84%

Source: Author’s analysis and “The Brave 100: The Battle of Supremacy in Small Business Lending.” QED Investors and Oliver Wyman. 2015.

97%

Borrower

Acquisition

Borrower

Experience &

Satisfaction

Customer/

Product FitCost of Funds

Underwriting &

Compliance

Costs

✔

✖ ✔

✖INCUMBENTS

DISRUPTORS

COMMUNITY BANKS

DON’T COUNT OUT THE BANKS AND TRADITIONAL LENDERS

22

97% 84%

Source: Author’s analysis and “The Brave 100: The Battle of Supremacy in Small Business Lending.” QED Investors and Oliver Wyman. 2015.

Borrower

Acquisition

Borrower

Experience &

Satisfaction

Customer/

Product FitCost of Funds

Underwriting &

Compliance

Costs

✔

✖ ✔ ?

✖ ?INCUMBENTS

DISRUPTORS

COMMUNITY BANKS

DON’T COUNT OUT THE BANKS AND TRADITIONAL LENDERS

23

97% 84%

Source: Author’s analysis and “The Brave 100: The Battle of Supremacy in Small Business Lending.” QED Investors and Oliver Wyman. 2015.

97%

Borrower

Acquisition

Borrower

Experience &

Satisfaction

Customer/

Product FitCost of Funds

Underwriting &

Compliance

Costs

✔

✖ ✔ ? ✖

✖ ? ✔INCUMBENTS

DISRUPTORS

COMMUNITY BANKS

DON’T COUNT OUT THE BANKS AND TRADITIONAL LENDERS

24

97% 84%

Source: Author’s analysis and “The Brave 100: The Battle of Supremacy in Small Business Lending.” QED Investors and Oliver Wyman. 2015.

97%

Borrower

Acquisition

Borrower

Experience &

Satisfaction

Customer/

Product FitCost of Funds

Underwriting &

Compliance

Costs

✔

✖ ✔ ? ✖ ✔

✖ ✖? ✔INCUMBENTS

DISRUPTORS

COMMUNITY BANKS

BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES

25

97% 84%

Source: Author’s analysis.

HighLow

High

Low

Level of

Integration

Investment of

Time & Money

Required

BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES

26

97% 84%

Source: Author’s analysis.

Refer Declines

HighLow

High

Low

Buy Loans

Level of

Integration

Investment of

Time & Money

Required

Arms-Length Strategy

BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES

27

97% 84%

Source: Author’s analysis.

Refer Declines

Offer Bank Products On

Online Marketplaces

HighLow

High

Low

Utilize Alternative Lender’s

Technology To Power Online

Application

Buy Loans

“White Label” Online

Application, Underwriting,

ServicingLevel of

Integration

Investment of

Time & Money

Required

Partnership Strategy

Arms-Length Strategy

BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES

28

97% 84%

Source: Author’s analysis.

Refer Declines

Offer Bank Products On

Online Marketplaces

HighLow

High

Low

Utilize Alternative Lender’s

Technology To Power Online

Application

Buy Loans

“White Label” Online

Application, Underwriting,

ServicingLevel of

Integration

Investment of

Time & Money

Required

Acquire Online Player

Build Own Product

Partnership Strategy

Arms-Length Strategy

Build or Buy Strategy

BANKS AND INCUMBENT LENDERS: OPTIONS FOR STRATEGIC RESPONSES

29

97% 84%

Source: Author’s analysis.

Refer Declines

Offer Bank Products On

Online Marketplaces

HighLow

High

Low

Utilize Alternative Lender’s

Technology To Power Online

Application

Buy Loans

“White Label” Online

Application, Underwriting,

Servicing

Internal Innovation Incubator

Long-Tail Strategy

Level of

Integration

Investment of

Time & Money

Required

Direct Equity Investments

Acquire Online Player

Build Own Product

Partnership Strategy

Arms-Length Strategy

Build or Buy Strategy

INNOVATION INSIDE BANKS: CASE EXAMPLE

30

97% 84%

Sources: http://www.builtinboston.com/2017/05/17/numerated-growth-technologies-launches-out-stealth-mode; https://twitter.com/easternlabs?lang=en; https://cibng.ibanking-

services.com/EamWeb/Account/Login.aspx?orgId=373_011301798&FIFID=011301798&brand=373_011301798&appId=CeB&FIORG=373

• ““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

Eastern Labs 1.0Eastern Bank Numerated

• 200 year old mutual bank

• Top SBA lender in New England

• Legacy systems

• Numerated spinout in May 2017

• Eastern 25% ownership

• Top-tier investors

• FIS

• Venrock

• Success for Eastern?

PHASE 3: WHO WILL BE THE WINNERS?

PHASE 1 PHASE 2 PHASE 3

• Rapid emergence

and growth of

hundreds of new

online lenders

• Partnerships

between

incumbents and

online lenders

???

Online Lenders

EnterPartnerships

Selected

Winners Emerge

PLATFORM PLAYERS ENTERING

32

97%

Platforms like Amazon have accelerated their lending volumes

Amazon Lending Statistics

• 20,000 small businesses

• $3 billion total loans

• $1,000 to $750,000

• 6-14% interest rates

Players to watch

Paypal

Alibaba

Square

Amazon

AmEx

Sources: “Beyond Fintech: A Pragmatic Assessment Of Disruptive Potential In Financial Services.” World Economic Forum. August 2017.

http://www3.weforum.org/docs/Beyond_Fintech_-_A_Pragmatic_Assessment_of_Disruptive_Potential_in_Financial_Services.pdf and Thurbon, Rob. “Amazon has lent over $3 billion to

merchants since 2011.” TechSpot. June 12, 2017. https://www.techspot.com/news/69665-amazon-has-lent-over-3-billion-merchants-since.html

Loans through Amazon Lending ($ billion)

PHASE 4: SMALL BUSINESS UTOPIA

PHASE 1 PHASE 2 PHASE 3 PHASE 4

• Rapid emergence

and growth of

hundreds of new

online lenders

• Partnerships

between

incumbents and

online lenders

??? • Affordable pricing

and high customer

service

Online Lenders

EnterPartnerships

Selected

Winners Emerge

Small Business

Lending Utopia

WHAT ROLE WILL REGULATION PLAY?

Office of the

Comptroller

of the

Currency

Federal

Deposit

Insurance

Corporation

Federal

Reserve

Office of the

Comptroller

of the

Currency

Consumer

Financial

Protection

Bureau

National

Credit Union

Administration

Securities

and

Exchange

Commission

CURRENT STATE: SPAGHETTI SOUP – MULTIPLE REGULATORS

35

97%

Source: Author’s analysis and GAO-16-175, “Financial Regulation: Complex and Fragmented Structure Could Be Streamlined to Improve Effectiveness,” March 2016.

Currently little oversight of small business online lenders

Depository

institutions

Federal

ReserveFDIC OCC NCUA FTC CFPB SEC Banking Securities

Non-depository

entities that offer

consumer

financial products

or services

Small business

online lenders

Broker-dealers or

other securities

and derivatives

markets

intermediaries

?

FDIC: Federal Deposit Insurance Corporation

OCC: Office of the Comptroller of the Currency

NCUA: National Credit Union Administration

FTC: Federal Trade Commission

CFPB: Consumer Financial Protection Bureau

SEC: Securities and Exchange Commission

State Regulators

Safety and soundness oversight

Consolidated supervision or systemic risk-related oversight

Borrower financial protection oversight

Securities and derivatives markets oversight

Financial Stability Oversight Council member agency

Federal Regulators

REGULATORY QUESTIONS

36

97% 84%

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?

ONE GUIDING PRINCIPLE: “DO IT SMART”

37

97% 84%

Small

business

marketplace

lending

FinTech

GovTechRegTech

Small

business

marketplace

lending

Small business lending is at the intersection of FinTech, GovTech, and RegTech

1. Issue clear, succinct, joint guidance

2. Engage industry

3. Use technology

4. Be data driven

WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE?

Banks

Credit Unions

TRADITIONAL

WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE?

Banks

Credit Unions

Disruption by:- Technology- Entrepreneurship

TRADITIONAL DISTRUPTORS

WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE?

REGULATORS

Banks

Credit Unions

TRADITIONAL DISTRUPTORSDisruption by:- Technology- Entrepreneurship

Office of the

Comptroller of

the Currency

Federal Deposit

Insurance

Corporation

Federal Reserve Office of the

Comptroller of

the Currency

Consumer

Financial

Protection

Bureau

National Credit

Union

Administration

Securities and

Exchange

Commission

WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE?

Banks

Credit Unions

Disruption by:- Technology- Entrepreneurship

?

Office of the

Comptroller of

the Currency

Federal Deposit

Insurance

Corporation

Federal Reserve Office of the

Comptroller of

the Currency

Consumer

Financial

Protection

Bureau

National Credit

Union

Administration

Securities and

Exchange

Commission

REGULATORS

DISTRUPTORSTRADITIONAL

WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE?

Banks

Credit Unions

Disruption by:- Technology- Entrepreneurship

?

WHITE HOUSE

?Office of the

Comptroller of

the Currency

Federal Deposit

Insurance

Corporation

Federal Reserve Office of the

Comptroller of

the Currency

Consumer

Financial

Protection

Bureau

National Credit

Union

Administration

Securities and

Exchange

Commission

REGULATORS

DISTRUPTORSTRADITIONAL

WHAT IS CHANGING IN THE SMALL BUSINESS LENDING LANDSCAPE?

Banks

Credit Unions

Disruption by:- Technology- Entrepreneurship

?

WHITE HOUSE

CONGRESS

?

?Office of the

Comptroller of

the Currency

Federal Deposit

Insurance

Corporation

Federal Reserve Office of the

Comptroller of

the Currency

Consumer

Financial

Protection

Bureau

National Credit

Union

Administration

Securities and

Exchange

Commission

REGULATORS

DISTRUPTORSTRADITIONAL

SMALL BUSINESS OWNERS