As crowd-funding becomes an established form of investing, banks are looking at ways to take on these crowd-funders, whether it be by collaboration or competition. 

Crowd-funding is no longer an innovation for start-ups regarded from afar. Banks are taking note and they want in.

Being part of a crowd means individual investors can get a slice of the action at an early stage, whether it is an equity stake in Silicon Valley’s next start-up or lending to an established company. Billed as the 'democratisation of finance', crowd-funding means investors and borrowers can meet online without an intermediary bank. While crowd-funding threatens banks with disintermediation, it also presents them with a new business model for borrowing and investing.

The range of crowd-funding platforms is vast and includes donation sites, where people can contribute to their favourite artist’s next project or fundraise for charity through sites such as JustGiving. For sites where users expect a financial return, the debt side has seen explosive growth in recent years, particularly in peer-to-peer consumer lending.

Explosive growth

Take Lending Club, the US crowd-funding success story, which had its initial public offering in December 2014. The prospectus outlines its rapid growth: loan originations more than doubled each year from 2008 to 2013, totalling $2.1bn at the end of 2013 and $1.8bn for the first half of 2014.

And in Europe, crowd-funding has also been growing rapidly. A report by consultancy EY and Cambridge Judge Business School estimates the alternative finance market grew from €2.1bn in 2013 to €2.96bn in 2014, with alternative lending in Europe expected to reach €7bn by the end of 2015. Of this lending in Europe, the UK takes the greatest share.

Jason Best, co-founder and principal at Crowdfund Capital Advisors, says: “The UK has the most vibrant [crowd-funding] market in the world.” This is in part because of the regulatory framework laid down by the Financial Conduct Authority. Other markets are following suit: in February 2015, for example, the Monetary Authority of Singapore released a consultation paper outlining its proposals for crowd-funding. Mr Best also highlights Thailand and Malaysia as markets that are quickly catching up. Through his work advising regulators in Asia, Middle East and Latin America, Mr Best says they are no longer asking what crowd-funding is, but rather what they can do about it.

Banks are also wondering what to do about it. While peer-to-peer financing is heralded as the means for individual investors to get involved in finance on a small scale, it is in fact large financial institutions that have been actively investing. Hedge funds, venture capital firms, large banks and other institutional investors have been investing through crowd-funding platforms, with some estimates that institutions account for more than half of the investors on peer-to-peer sites such as Lending Club and Prosper.

The majority of the peer-to-peer market is funded by institutions, says Warren Mead, head of challenger banking and alternative finance at KPMG. “Peer to peer is illusory – it is actually peer to institution,” he says.

Property please

One of the fastest growing segments in crowd-funding to gain attention in recent months is property. A March 2015 report by Massolution notes that more than $1bn of capital was invested in real estate through various crowd-funding platforms in 2014.

Crowd-funding platforms can be the modern version of the real estate investment trust, where investors own a portion of the equity. For example, the Hard Rock Hotel in Palm Springs raised $1.5m through a crowd-funding platform by selling a 15% stake to dozens of investors with a minimum investment of $10,000 each.

Crowd-funding can also be used on the debt side, as an extension of peer-to-peer lending into secured, longer term mortgage loans. Steven Cinelli, a senior fellow at Massolution, believes residential mortgages will be one of the greatest opportunities in crowd-funding. “Investors, given the low-interest environment, are looking for yield but shy of risk, so residential mortgages represent an asset class of interest,” he says.

Mr Cinelli points to LendInvest in the UK, which in 2014 originated about £160m ($235.9m) in loans. “Then you have [student loan refinancer] SoFi in the US about to embark on a huge residential mortgage initiative,” he says.

Rethinking mortgages

When asked how this relates to banks’ involvement in mortgages, Mr Cinelli says: “If you look at the banking sector, particularly in the US, the banks do originate mortgage loans however very few they actually hold. The mortgage market in the US for 2014 included about $1000bn of new loans, of which most were sold to government-sponsored agencies – namely Fannie Mae and Freddie Mac.” He adds that the overall US mortgage market has about $8000bn in outstanding loans, of which the banks only hold just over $3000bn. The US banking system does not have the capacity to hold the loans and new forms of investors are required, he says.

Mr Cinelli is also the chief executive and founder of Primarq, a real-estate equity platform that seeks to move away from the single-investor/single-owner model of housing where the homeowner is highly leveraged with a large mortgage. Instead, investors can inject capital into a property to supplement the homeowner’s equity, thus reducing the amount of debt on each property. “[This effort] really attempts to change the nature of housing finance, by inserting equity finance into the mix rather than high levels of leveraged financing – ie, debt – which contributed to the financial crisis in 2007 to 2009.”

Mr Cinelli argues that banks are at a disadvantage to the alternative finance platforms because the “regulations to provide safety to borrowers and depositors actually undermine banks’ competitiveness”. The capital requirements of Basel III, for example, “handcuff” the banks in what they can and cannot do.

“Banks and their regulators need to understand that the current intermediation by the platforms not only compete, but could in the long term provide a death knell for the regulated banking market,” says Mr Cinelli.

Mr Cinelli predicts that banks will either “figure out how to compete” or more likely partner with unregulated platforms or move to other types of loan products.

Collaborate and prosper

Mr Mead says banks will actively counter the threat from crowd-funding. “I cannot imagine the banks sitting back and doing nothing,” he says, adding that in recent months there has been more interest and greater willingness by banks to collaborate, particularly in business lending.

In June 2014, Santander UK agreed to refer some of its customers who otherwise would have been rejected by the bank for a loan to Funding Circle, a peer-to-peer platform that specialises in lending to businesses. In return, Funding Circle would promote Santander’s banking services such as cash management. At the time of the announcement, Ana Botín, then-CEO of Santander UK, said: “SMEs [small and medium enterprises] need access to multiple sources of finance and Santander’s partnership with Funding Circle is a good example of how traditional and alternative finance can work together to help the country's SMEs prosper.”

Later, in January 2015, RBS announced that it would also refer customers to Funding Circle and Assetz Capital. Alison Rose, chief executive of RBS’s commercial and private banking division, said at the time: “We are committed to doing the right thing for our customers by helping them access finance where we cannot help them within our current risk appetite.”

In another example of banks partnering with crowd-funding platforms, Prosper signed an agreement with Western Independent Bankers, a group of local banks in the US in February 2015. Through the arrangement, customers at the community banks would be able to access consumer loans through the Prosper platform.

Deal flow advantage

Sherwood Neiss, principal at Crowdfund Capital Advisors, notes that banks have the advantage of deal flow. By partnering with a platform, they can see where the money is flowing without having to do the “heavy lifting” of lending their own money. Also, with real estate crowd-funding sites, for example, first-time developers who would not normally qualify for a bank loan have the opportunity to establish their credibility with the crowd. Banks can then take this into account when assessing them for their next loan.

Mr Best notes that banks that refer business customers to crowd-funding are able to keep the relationship with the customer and the bank has an opportunity once those companies become bankable.

James Tuckett, founder and managing director at crowd-funding site aggregator UP, argues that the customer referrals are “predominantly for PR purposes as it offers very little benefit to the banks themselves”. In the UK, there is proposed legislation looming over the industry that would force banks to refer business customers to crowd-funding sites if they are unable to lend to them. This is happening in an environment where there is political pressure on banks to lend to small businesses.

Mr Tuckett says other changes are also impacting upon banks: pension reforms mean individuals are rethinking their investment options; wealthy clients are more interested in the alternatives; and borrowers are finding peer-to-peer sites more convenient and competitive than borrowing from a bank.

Getting banks involved

UP, which launched in February, is currently in the process of signing up sites to its platform with the aim of creating an online supermarket of peer-to-peer options. It is free for sites to list on UP and free for users. UP is currently working on a solution that will allow banks to distribute their loans to the crowd for a fee.

In another example of how banks can get involved in crowd-funding, San-Francisco-based Union Bank agreed to a strategic alliance with Lending Club in May 2014, whereby the bank would purchase loans through the peer-to-peer platform. As part of the agreement, both parties said they would work together to create credit products that would be available to the customers of both Lending Club and Union Bank.

In South Africa, one bank has become more directly involved in crowd-funding by purchasing a stake in a peer-to-peer marketplace. In March 2014, Barclays Africa bought a 49% stake in domestic peer-to-peer lender RainFin. At the time of the announcement, Sean Emery, chief executive of RainFin, said: “This shows that the peer-to-peer lending model has come of age in South Africa and this transaction brings the concept into the mainstream of the country’s financial services sector.” The company also stated that Barclays’ investment would enable RainFin to develop its products for corporates, and include supply chain finance and mid-sized corporate debt products.

Mr Neiss also sees the opportunities in this type of product and believes that they will feature in the next phase of crowd-funding. For example, equipment leasing or asset-based lending could soon be offered to the crowd. In his view, this is not necessarily bad news for banks. “Crowd-funding does not displace anyone – it fills a void that banks cannot seem to fill on their own,” he says, adding that there are also opportunities in international trade finance and letters of credit.

Another way for banks to be involved in crowd-funding is in being the bank that stands behind the crowd-funding platform. While Lending Club is promoted as a peer-to-peer site, it is structured as a bank that both issues and originates loans. WebBank, a Utah-based industrial bank, is doing the actual lending to the borrowers. Rather than borrowing directly from investors, WebBank stands between the parties and is the actual lender. The borrower applies for a loan through Lending Club, but it is actually WebBank funding the loan. Lending Club creates a structured note for that loan, which it then sells to investors.

Banks have the option of getting involved in crowd-funding in this way. And for banks starting from scratch, crowd-funding is a consideration from the outset. Digital start-up banks, such as Germany’s Fidor Bank, have been established as an open platform more akin to an app store, where users can download the apps and services most relevant to them. With such a set up, crowd-funding is an option that customers can plug into the portal provided by the digital bank. Such a principle is how e-money institution Ipagoo has been designed from the outset (see Ipagoo joins the EU dots to beat the regulators).

With these options for banks to get involved in crowd-funding, it is no longer a case of whether banks will take it seriously, but when. Mr Best says: “In five years we won’t talk about ‘crowd-funding’ – it will just be funding.”


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