With the total addressable market reaching over $ 4 trillion, the alternative market is evolving aggressively to balance the retreat by traditional banks. The existing market for market place lending is undergoing rapid transformation and is on throes of consolidation with only serious players in fray, with opportunities for scaling being left to take on business, in its current form. Banks are also becoming aggressive in their drive towards digitisation exploring multiple options of in-house accelerator hive-offs, buying, building or partnering with existing on-line lenders, offering digital experience to clients as ways to protect business turf, improve processes and meet the expectations of tech-savvy clients and businesses. Lending-as-a-Service (LaaS) provides ‘technology’ to brands instead of ‘funds’ directly to businesses and clients. The business model under LaaS prescribes selling platforms to banks instead of lending by themselves.
Evidence so far, however, suggests that algorithms have not yet safely cracked the mysteries of lending to a diverse, and often speculative sector of the economy where ideas, dreams, hype and numbers often end up in a shapeless pile of financial wreckage. Moreover, the cost of lending can end up being high for the borrowers. More banks are predicted to launch their own online lending platforms with the continuing spree of many non-bank online lending platforms being acquired. It is also a fact that non-bank actors are increasingly becoming a subject of prudential data management multiplying potential risk when they are chartered for banking functions.
What is Lending-as-a-Service (LaaS)?
Instead of a peer-to-peer-style lending marketplace, LaaS provides software to retailers, banks and other businesses whose customers may need financing. LaaS provider undertakes risk assessment, underwriting and funding, with the advantage of brand being given to the loan-originating partner.Lending-as-a-Service is in a way upending the balance sheet lending market and takes different forms and variants with ‘Decisioning-as-a-Service’, ‘Software-as-a-Service’ or ‘Banking-as-a-platform’ are a few of them to name.
Emerging hybrid model of lending
With investors looking for both good returns and better security of funds, there is already a swing towards market place lending model from balance sheet lending. Balance sheet lending with its inherent risk for investors presupposes a trusted originator sailing with conflict of interest dictated by their own underwriting models. For banks LaaS model is a new ground to test waters of their online lending ambitions without investing on building the platform and still test their own underwriting framework and decide to piggy ride on techies based on how this pans out in showing potential to reach scale.
As some of the brands like merchants, retailers and in many cases banks as well are constrained by limitations of small window of financing, LaaS is seen as a god-send opportunity to deepen relationship with customers without taking on credit risks themselves and yet allowing them to use their own brands.
What this means for banks?
Banks stand to gain their brand by partnering with LaaS providers, as such platforms can be used by incumbent banks to automate the entire lifecycle of loans through cashless, paperless, hassle-free and quick process. LaaS combines the advantage of speed of FinTechs with banks’ strong funds flow, with the software platform locating prospective clients to match banks’ loan standards. Banks are much better to compete with their digital competitors through such white-labelled lending as a service arrangement and enjoy complete outsourcing of their entire online lending function. Banks can benefit customers by passing on the cost saved on manpower and credit risks and still gain by their brand mileage, as clients on-boarded will directly land into banks’ website on business credit, integrating into banks’ credit policies. The white labelling solution is evolving with some players offering to banks more sophisticated platforms like Blockchain Lending Platform as a Service (BLPaaS) which banks can leverage for cross-border payments and facilitate factoring.
Resurrecting the dying banking products
Of the neglected financial instruments invoice finance, inventory lending, factoring, trade finance and working capital may need a leg up as they are mired by regulatory woes, identity challenges, currency volatilities, payment delays and economic uncertainties, with the present business models of both banks and FinTechs unable to address the pain points.
Connecting the dots in the cross-border payment demand new digital solutions mainly to overcome the monsters of KYC (Know Your Customer) and AML (Anti Money Laundering) which are also killing genuine business transactions many times in unbanked markets. Regulations and compliances many times are not seen as enablers, but technology is proving to be overcoming such speed bumps. One other neglected financial needs of small businesses is the inventory finance, whether it is retail, seasonal or wholesale businesses, there is considerable gap both for existing inventory or receivables with traditional players getting shy of asset-based lending. With credit score taking a back seat, the quality and value of inventory management become important with the focus more on big tickets. LaaS model can shift the risk out of banks and yet give the mileages of scale and trust to the technology provider.
In UK alone over UKP 2.5 billion is stuck due to unfair payment practices, at a time when public disclosure requirement on average time taken by large firms is seriously being contemplated, the new model will enable parties regain the lost trust. The future of commerce ecosystem for small businesses, where all parties win, is what an integrated payment system can guarantee through a payment-embedded platform. This can potentially cut down costs, time and more importantly recoup the much needed cash flow for small businesses suffering from the complexities of cash flow ratio (between the average period to pay the supplier, process the supplies and collect from the customer)
Trade finance being less riskier may need a different approach from the regulator, with banks requiring to move the risk assessment from company level to transaction level in the whole supply chain and interoperability through common standards need to evolve to look at customs, logistics, shipping, and finance layers digitised across.This may need a new approach from FinTechs through simplification of processes and tracking transactions for addressing bank level hang-overs. Even with improved banks’ sensitivity at least in some geographies like US with commitment to expand lending, there is staggering $1.5 trillion trade finance gap, with 40% sitting in Asia-pacific region and 74% accounting for small businesses and mid-caps. It is estimated that to facilitate half a trillion dollars of trade annually, a team of 4,000 people is required to review 100 million pieces of paper manually. With the trade growing below the GDP for the first time heading for severe dislocation, it is time the business model of AltFin gravitates towards less-riskier operating model benefitting themselves and also banks.
Equally for small businesses, platforms like Quickbooks, E-Bay, Etsy, Freshbook and Xero offer turn-key solutions to negotiate and align with the fast- changing technology world. With cloud based tools proliferating, more small businesses are looking for end-to-end solution to manage their business processes. Cloud applications, or software-as-a-service apps, are transforming business at companies of all sizes, allowing them to quickly set up productivity-boosting technology to replace manual activities and on-site enterprise software. Gartner forecasted that cloud apps would grow 20% to $46.3 billion globally during 2017.
LaaS model is gaining to see a new traction with more partnerships emerging. With the likes of OnDeck, Ezbob, Akouba, LendKey, Insikt, Spotcap, Kabbage, Mambu (though it is more of SaaS), Penta and Biz2Credit choosing to tread on the path of LaaS model, there is emerging interest in the new model in their quest towards reversing the underperforming financial market by aggressively seeking to integrate newer and non-traditional financial instruments struggling to resolve pain-points in payment, lending, remittance and trading spaces dying to serve largely an unbanked market aspiring to capitalise through card and phone-based payments.