It is of course clear in the wake of Lending Club’s catastrophe that the high-wattage disrupter model that has made so many billions in Silicon Valley does not have a manifest destiny ensuring triumph in U.S. financial services. Those of us who’ve been around for a bit remember the market’s infatuation with subprime mortgage lending and saw in P2P an even more lethal concoction of Silicon Valley hubris and high-risk credit origination premised on the “get-out-quick” model that turned out quite badly the last time around. P2P hasn’t of course amassed systemic lift-off volume – at least not yet – and its current travails are thus limited to those who saw yet another quickie pot of gold. Down, though, does not at all mean out for fintech-delivery models because the damage to the bank retail-finance franchise done by the crisis makes regulated banking unusually vulnerable to adroit competitors – and there will be some even if Lending Club and its colleagues falter this time around. Can banks show the value-add of their more costly, regulated business model in time to keep them in the financial-intermediation game?
To answer this question, one needs to know if the P2P model is premised on assumptions that won’t pan out once the fast money moves on or if the business model has the long-term disruptive force of Uber for taxis and Airbnb for hotels. To analyze this, I first discount some of the usual high-flying trappings of Lending Club and its peers – adding Larry Summers to your board, getting one’s face on CNBC, and the like. Theranos and its former Cabinet-Secretary full board is a precursor of Lending Club’s star turn, but so too is its rapid transformation from glamor start-up to disastrous blow-up.
The reason I think is not only that the really high-power disrupters worked hard in obscurity putting their businesses together bit by bit before bursting into sight claiming billions in market value. Each of these disrupters also did something else very different than new firms like Theranos and, now, the fintech players – they picked sectors where the rules, such as they were, didn’t make much sense in terms of value-add to product delivery. For taxis, the rules served largely a monopoly function keeping dirty cabs with ignorant, discourteous drivers on the road and thus were not a meaningful barrier to entry once consumers realized they had an option. Hotels are largely unregulated, making barriers to entry even more ephemeral.
For biomedical companies like Theranos, rules matter because people’s lives are literally at stake. For P2P lending, rules matter because – again think subprime mortgages – innocent customers can be truly victimized by high rates, false promises, and all the pain that comes with taking loans one lacks the ability to repay. In short, Uber and many successful disrupters played only with their own money; fintech start-ups all too often play with other people’s and that’s why there are rules that, unlike in other sectors, really matter.
But marketing that preserves banking means marketing that shows why rules matter not just in theory, but also for consumers. To do this, banks will have to make consumers understand that banks are indeed more trustworthy with their money and better stewards of their indebtedness than less-regulated firms offering seemingly-comparable services. This is going to be a very hard sell in the wake of the financial crisis.
The reason fintech looks now like a winner is that banks have so badly damaged the franchise value of their retail-finance operations in the crisis that no one trusts them any more than the high-flying start-ups with all their fancy-dancing flourishes. Think about how taxi companies are now so desperately trying to assure passengers that a medallion cab is safer than Uber and see what happens when rules are not seen as a meaningful protection when a better, cheaper, faster option is at the tip of one’s smartphone-enabled fingers. Banks now have a unique window of opportunity to reassert their franchise value while P2P is on the pavement. Doing this will, though, take more than some of the financial-engineering improvements several banks are rushing to market – it will also take firm proof of the principle that banks are better than unregulated competitors because banks take precautions and ensure protections that count to consumers. Given recent history, this is a formidable challenge, but it’s a critical one not just for banks, but also the regulators who, even if they don’t believe in banks, know how important their rules have proved to be.