06/11/2013By Edwin Herrie, Head of Banking, KPMG in the Netherlands
When Eric Migicovsky, founder of Pebble Technology, was looking for a second round of funding to market his internet-enabled watch, he hit a roadblock: no-one wanted to kick in the cash.
But where, traditionally, entrepreneurs had few options for raising capital besides going to a bank for credit, Migicovsky turned to crowd-funding website Kickstarter with a modest fundraising target of USD100,000. Within two hours, he had met his goal. Just over a month later, funding was closed after some 69,000 backers pledged more than USD10 million to be among the first owners of Pebble.
Everyone a banker?
Clearly, crowd-funding is changing the way individuals, businesses, charities and even soccer teams and fledgling rock bands raise cash. But is it a threat to the bottom line of traditional banks? Or does it uncover new business models, particularly in developing markets or high-risk sectors?
Equity-based crowd-funding – where investors receive an ownership stake in a company – has tended to be the fastest growing sector of crowd-funding in the developed world (up 114 percent in 2012). What is more, there is every indication that the trend should accelerate rapidly once US regulators legalize the approach, likely in 2013 or 2014. Until then, Seedrs in the UK reigns as the leading equity-based platform, enabling individuals to invest anything from GBP10 to GPB150,000 in start-ups they choose online.
But the risk to investors – who are often left to their own devices to separate a good investment from a bad one – is certainly real and a presents investors with a strong motivation for remaining with traditional investment advisors. And while a robust vetting process by the crowd-funding platforms and real regulation around equity crowd-funding could help mitigate this, it may also lead to costs rising to a point where equity-based crowd-funding becomes just as expensive as traditional borrowing.
Skipping the middle-man
Another potential disruptor to traditional banking models is peer-to-peer lending where lenders are connected directly to borrowers looking to finance anything from debt consolidation to an engagement ring. Lending Club, one of the leading peer-to-peer lending platforms in the US, boasts former US Treasury Secretary Lawrence Summers and ex-Morgan Stanley CEO John Mack as directors and expects to lend around USD1.5 billion this year.
And while those numbers may pale in comparison to those put on the board by the likes of Bank of America or Chase, there are indications that the pot may keep growing. Prosper, another US platform, is also growing quickly, as is Zopa in the UK.
One inhibitor to growth for most of these platforms, however, is their stringent borrowing criteria. Lending Club’s personal income requirement means that only 10 percent of the US population would qualify to use the service. This creates a conundrum: broadening the criteria would drive growth for the platform, but it would also threaten investors’ high rates of return (typically 6 to 18 percent for over 90 percent of their investors) as less credit-worthy borrowers default or renegotiate their terms.
A greater flight-risk for traditional banks might be small businesses. While the US banks may have loaned more than USD282 billion to small businesses in 2011 (versus the USD1.47 billion that was loaned via crowd-funding platforms), most traditional loans went to businesses with USD3 to USD50 million in annual revenues, leaving the bulk of American small business owners looking for other – more accessible – funding options.
If you can’t beat ‘em…
So, should traditional banks be afraid of increasingly democratized financial markets? The jury is still out. While there are certainly underserved market segments that may abandon traditional institutions in favor of crowd-funding, there are few signs that equity investors are currently in the mood to take on more risk.
That is not to say that crowd-funding and peer-to-peer lending won’t disrupt the growth of the banking sector in countries and regions where banking infrastructure is sparse. Experiments in crowd-funding in Africa and Asia have delivered strong results, particularly in areas where mobile phone penetration outstrips that of banking. For now, however, most of the larger platforms are based in the UK and the US and require participants to be residents.
If traditional banks do start to feel the heat, they could always take from the strategy of tiny upstart WebBank, a chartered industrial bank based in Salt Lake City, Utah. WebBank funds all of Prosper’s and Lending Marketplace’s personal loans and, in doing so, suggests that there are certainly opportunities for traditional banks to take a role in the crowd-funding value chain.
The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in the Netherlands.