At the very intersection of digitalization and globalization, the finance industry is constantly innovating; looking for ways to transcend borders and red tape as we speak to stay relevant. Consumers and businesses alike are searching for financing solutions outside of the remit of traditional banks and investors: with emphasis on processing speed, approval leniency and nuanced methods of gauging credit history. With alternative finance becoming less ‘alternate’ as the days progress, here are six trends shaping the space today.
1. Popularity of alternative business finance continues to be influenced by bank loan approval rates for SMEs
It is no secret that small and medium-sized enterprises (SMEs) face larger financing barriers due to the lack of credit history and substantial collateral. However, the ease of access to finance varies tremendously from region to region — in the US, 80% of bank loan applications by SMEs are rejected compared to only 27% in Europe. Differences in predicament, are in part, reflected in the European Central Bank’s 2017 survey: Access to finance was considered the least important concern of European SMEs, and only 20% of SMEs are interested in using alternative finance, such as peer-to-peer (P2P) lending and equity crowdfunding. In 2016, a total of US$ 8.8 billion of alternative business finance was raised in the US, compared to only EUR1126 million in Europe; most of which originates from debt models (P2P, invoice trading, etc.). Incidentally, a similar shift towards alternative lenders by real estate investors in the mortgage space can also be attributed to banks feeling spooked by subprime mortgage crisis and their refusal to finance non ‘A-grade’ clients.
2. Businesses still prefer debt over equity, even in alternative finance
Businesses large and small often choose higher debt financing over equity, and this inclination shows no sign of changing. According to researchers at the Cambridge Centre for Alternative Finance (CCAF), debt models (including P2P Business Lending, Invoice Trading, etc.) accounted for 67% of all alternative business finance in Europe, while equity models (Equity-based Crowdfunding, etc.) only accounted for 27%. In the US, US$6 billion out of the total US$8.8 billion of alternative finance raised originated from balance sheet business lending alone.
3. 2018 will see an increased multi partner approach to alternative finance, with significant emphasis on institutionalisation
The alternative lending industry has experienced significant consolidation over the last year, with a ‘wave of acquisitions, mergers, and shutdowns’ expected to continue well into 2018. Institutionalisation (defined as traditional finance players entering the market) increased considerably from 2015 to 2016, with 45% of P2P consumer lending, 29% of P2P business lending and 13% of the investment in equity-based crowdfunding was funded by institutions such as pension funds, mutual funds, asset management firms and banks. Case in point, investment banking titan Goldman Sachs recently launched their own balance sheet online lending platform named Marcus. Other institutional players may prefer to join in the altfi action by acquiring instead of developing their own in-house capabilities; for example, ABN AMRO bought and integrated solarisBank’s online lending service into its preexisting digital brand Moneyou.
4. P2P Consumer lending remains the most popular form of alternative finance around the world, except for Canada
The CCAF reports also noted that P2P consumer lending accounts for the largest market segment of alternative finance in Europe (excluding UK) for a 3rd year since 2014. P2P consumer lending contributed 34% of all alternative finance raised, and as a constituent model grew by 90% from €366m in 2015 to €697m in 2016. Other forms of alternative finance in Europe include, in descending popularity: P2P business lending (17% of market share), Invoice Trading (12%), equity-based crowdfunding (11%) and reward-based crowdfunding (9%). Across the Pacific, marketplace/ P2P consumer lending continued to account for the largest share of market volume with $21 billion recorded in the US in 2016 (up 17%). Oddly, donation-based crowdfunding was the top alternative finance model in Canada with $105.9 million; with balance sheet business lending trailing closely behind at $103.3 million in 2016.
5. Risk concerns are similar across the board and will likely persist
Self-reported risk perceptions of the alternative finance industry are surprisingly similar across markets in the Americas, with the largest reported risk being cyber-security breach. 76% percent of platform operators believe there is medium to very high risk of cyber-security breach. According to CCAF’s reports, the “collapse of one or more well-known platforms due to malpractice” ranked among highest in perceived risks to platforms in both North America and Europe, likely reflecting some of the repercussions of recent high-profile incidents within the industry. “Fraud’ and “notable increase in default or business failure” were both regarded by 64% of surveyed platforms to be medium to very-high risk.
6. Higher regulation begets higher volumes of alternative finance
Perceptions of adequate and up-to-date regulation is associated with higher volumes per capita and higher share of business funding. Based on an analysis of 17 countries, researchers at the CCAF observed a trend line suggesting that the greater the share of platforms indicating that existing regulatory framework is adequate in their countries of operation, the more likely are these countries to have higher levels of alternative finance per capita, as well as a larger share of business funding out of total alternative finance volumes in the same country. However, whether the trend is actually linear remains a question: nearly every country in the EU has a varying limit on the maximum amounts of money that can be raised via alternative finance sources; the list of which can be obtained here. With the European Union’s revised Payment Services Directive (PSD2) implemented earlier this year, banks will now need to allow access their data to third parties upon request by clients. Compounded with the anticipated release EU fintech plan, both regulatory frameworks will further encourage disintermediation, enable niche players to gain scale and therefore expanding the market for alternative finance.