Investment banks and commercial banks have traditionally maintained separate spheres, the former focusing on the buying and selling of securities and the latter on deposits and customer loans.
In recent years, however, investment banks have started to compete indirectly with commercial banks by funneling millions of dollars of capital into alternative online lenders such as OnDeck and BondStreet. Alternative lenders compete with commercial banks in providing loans to small business owners – their added value is that they are much faster than banks and are able to provide loans to subprime borrowers.
Why are investment banks encroaching on commercial lender territory, and will we see more? It looks like investment banks just want to profit from online lending to small businesses, which are already a $ 10 billion industry and growing rapidly. It is likely that investment banks will continue to support online lenders so that they (and their clients) can reap the financial benefits of small business loans without being penalized by the regulations that commercial banks must comply with.
(Disclosure: Author Marc Prosser is the co-founder and publisher of FitSmallBusiness.com, which has financial relationships with OnDeck, Lending Club, and Dealstruck).
Online lending to small businesses and the extent of investment bank support
There isn’t a lot of data currently available on alternative loans, but a recent Harvard Business School study estimated that online lenders have over $ 10 billion in small business loans outstanding. This number is almost 70 times lower than the amount of loans that traditional commercial banks collectively hold.
However, the popularity of alternative loans is increasing rapidly. To take just one example, leading online commercial lender OnDeck granted $ 416 million in loans in the first quarter of 2015, an 83% increase from the previous year. Former US Treasury Secretary Larry Summers recently estimated that over the next decade, non-bank alternative lenders could issue up to 75% of all small business loans!
Alternative lenders are popular for several reasons. First, they offer loans to people who run successful businesses but are unable to get a bank loan due to bad personal credit. Second, even for those with good credit, online lenders use technology that makes getting a loan much faster and easier than getting a bank loan. Online lenders are significantly more expensive than banks, but customers seem willing to pay for the value and convenience they offer.
Recognizing that alternative lenders are the way of the future, investment banks have invested millions of dollars in these companies. OnDeck raised $ 100 million from Goldman Sachs in 2012 and $ 130 million from Deutsche Bank in 2013. In June, online lender Bond Street raised $ 110 million from Jefferies Group, a global company of investment banking. Dealstruck and other alternative lenders have also raised funds from investment banks.
Investment Banks Enter Small Business Lending Regulation Without Regulation
By funding lenders online, investment banks can participate in their growing profits without facing the regulations that commercial banks must comply with.
Although commercial banking is not as heavily regulated as consumer banking, there are several levels of commercial banking regulation. Regulations at the federal and state levels affect, among other things, how banks secure funds, disclose and announce interest rates, secure customer personal data, report loan data and the capital they need to have .
Unlike the highly regulated commercial banking industry, “the small business online lending industry is largely unregulated.” This may change in the future. Recently, for example, the US Treasury launched a study on peer-to-peer lenders such as Lending Club. These lenders focus more on consumer loans, but they also provide business loans, and the government’s foray could lead to regulation for non-bank lenders in the years to come.
Even if so, investment banks can participate in small business lending behind the scenes, without regulatory constraints, by providing capital to alternative lenders. And while this may not be their intention, by relying on online lenders, investment banks end up indirectly competing with commercial lenders who lose business to non-bank alternatives.
Just history repeating itself?
While investment banks may be trying to avoid regulation, their capital spending for online lenders also suggests that they can test the waters of small business lending themselves.
The Glass-Steagall Act, enacted in 1933, separated the activities of investment banks and commercial banks. The law prevented commercial banks from selling or buying stocks with clients’ money, and investment banks were not allowed to take deposits from clients or make loans.
When the law was partially repealed in 1999, the line blurred between investment banks and commercial banks. Commercial banks began trading in stocks and bonds (some credited this with contributing to the 2008 economic crisis), and some investment banks like Goldman Sachs began to accept deposits from clients and grant loans. ready. By diversifying their portfolios and engaging in multiple activities, both types of banks have increased their bottom line.
Tying their profits to those of online lenders could be a way for investment banks to learn more about alternative lending and ultimately determine whether to engage in online lending. In fact, in June of this year, Goldman Sachs announced plans to launch an online consumer lending platform and, later, an online lending platform for small businesses. If alternative lenders become more profitable over the next few years, and the data suggests they will, I won’t be surprised if other investment banks follow suit.
Of course, commercial banks don’t sit idly by while online lenders (and now investment banks) eat their lunch. They treat their rivals like allies by forging partnerships with online lenders. For example, last year BBVA Compass Bank partnered with OnDeck, agreeing to refer borrowers to OnDeck when they are not eligible for a bank loan. If more investment banks start offering loans online, we might also see collaboration between commercial banks and investment banks.
A few years ago, Aaron Greenspan, CEO of Think Computer Corporation, predicted that “given current market trends, retail banking as we know it today will not exist by 2020”. Investment banks are probably seeing this coming and have decided to support online lenders who, if Greenspan is right, could very well replace commercial banks in the next few years. Some investment banks like Goldman Sachs have gone further by considering becoming online lenders themselves. We don’t know what the future holds. But now, commercial banks have new competitors backed by old investment banks, putting the two parties in indirect but significant competition.