WHAT IS DRIVING THE POPULARITY OF NON-BANK LENDING? THE NEED FOR ALTERNATIVES!

What is driving the growth of non-bank credit? The popularity and growth of non-bank or alternative lending may be occurring for different reasons. The users of credit may be consciously shifting away from banking channels due to the attractiveness of alternatives such as FinTech product offerings (the diagram to the left from Kaplan & Co illustrates its growing product offering). For example, one study indicates that over 15% of digitally active consumers have adopted FinTech product offerings such as savings and investment, payments, borrowing and insurance services (Gulamhuseinwala, Bull and Lewis, 2015).  These authors writing in publications for the Federal Reserve Bank of Richmond posit that falling costs of financial technology and government support have promoted competition in financial services towards non-bank sources.

But another aspect of the growth of non-bank credit may be a decline in the availability of traditional banking services to consumers and businesses, including the decline in bricks and mortar branches and forced bank lending retrenchment and de-leveraging.  Effectively, credit consumers must resort to non-bank channels for to fully and competitively meet their financial services needs. The purpose of this post is to consider recent research into the decline of traditional banking services and understand more what is driving this phenomenon.  Authors McCord, Prescott and Sablik (2015) find a substantial decline in the number of commercial banks in the US since the recent financial crisis period.  They indicate a 14% decline in the number of independent US commercial banks since 2008/9, a reduction of some 800 banks in the US.  Interestingly, they observe that the reason for this decline is in fact a collapse of new de novo bank entries in the US.  From 2002 to 2008, there were on average some 100 new banks established each year.  However, their research indicates that since the crisis period, new bank entrants have collapsed only several per year in fact.

The reason for this collapse is not entirely clear, but these authors believe that a combination of greater bank regulation and growing compliance costs, weak economic conditions, perhaps a tougher environment for capital raising and declining net interest margins may be part of the explanation. I would offer up the challenges associated with ensuring scale for a new commercial bank charter may also be a further rationale. Large banks wield considerable market power and can effectively buy business and drive margins lower for smaller competitors.  Further, the above noted growing compliance costs can impact smaller firms disproportionally, compliance systems in effect have a minimum cost regardless of bank size, thus discouraging new banking entrants.  Finally, larger banks can be more relevant to customers and offer a broad set of services on a cost effective basis.

This issue of bank efficiency and profitability potentially impacting smaller banks more so than larger platforms suggests that FinTech may offer a real alternative to consumers who would otherwise seek out smaller new banks.  It may also suggest that community banks, even more than large banks, might investigate partnerships with FinTech players as a survival technique and a means to differentiate cost effective financial services.