This post originally appeared on Able CEO Will Davis's personal blog here.
There’s been much talk lately of the uberization of banking. Implicit in the term is that disruption is inevitable and the banking industry as we know it is dead. To fan the flames, SoFi recently launched their “bankless world” campaign with a high profile Super Bowl commercial.
First, let's step back and marvel that the term “uberization” has made its way into the popular lexicon. Mind you, Uber wasn’t even a company six years ago — today, it’s valued greater than all taxi companies combined. Perfect case in point that banking is dead? Not exactly.
Yes, disruption usually leads to the death of incumbents. After all, you don’t see many phone books lying around these days — the interwebs solved for that. But why is banking different?
It’s different because banks hold deposits and lend off these deposits. This means that they take your money and lend it to me. You see, banks were “peer-2-peer” before “peer-2-peer” was a thing. There exists no more efficient means of sharing capital than the concept of a bank. And there’s also nothing more risky. If a bank can take my cash, multiply it by 10, and then lend it to you, they better make sure that you’re not too risky. Collectively, we’ve accepted this inherent tradeoff and have limited the risk bands banks can lend in.
“Thus, the paradox of lending: the very constraints that enable the most efficient lending capital also create the necessity for less efficient lending capital. You can’t have one without the other.”
Because we want banks to be risk-averse, we regulate the types of loans they can make. We can argue all day long if we’re in a period of over-regulation, but the concept of risk aversion in banking is sound. This is not to say risks shouldn’t be taken, only that certain types of risks shouldn’t be taken by banks. They should made by other types of lenders altogether.
This is why non-bank lenders exist. Since they procure their raw material from alternative sources, alternative lenders can take risks that banks should not. This type of capital procurement is less efficient than deposits, but it enables greater risks to be taken, and thus greater rewards to be made. Sophisticated investors supply the raw material of alternative lenders, and the Market ensures they are properly rewarded, or severely punished, for the risks they willingly take.
Yes, alternative lenders can outcompete banks on speed and user experience, but speed and user experience are not sustainable competitive advantages. They can be bought and sold like commodities. What cannot be disrupted is the inherent pricing efficiency of a depository lender. In fact, you could argue that it shouldn’t be.
Whenever the risk band of a loan matches the risk tolerance of a bank, the bank will always win on price. There will be periods when technology and innovation counterbalance pricing power, but pricing power will always win as the technology itself becomes commoditized — a type of Moore’s Law of innovation adoption.
On the flip side, banks can never compete with alternative lenders in the higher risk bands associated with non-depository capital. Its not as though they can’t catch up to innovation, it’s that they will be legally prohibited from competing in these risk bands. And rightly so.
Where there are overlapping risk bands, the markets will mete out the winner. Not because one outcompetes the other, but because the risk of the asset class will dictate the proper supply of capital.
So how should banks and alternative lenders work together? Shameless plug coming… just like Able is working with banks!
When Able partners with a bank, we do so because the bank cannot make the loan. Again, it’s not that the bank doesn’t want to, it’s usually because they are legally prohibited from doing so.
Instead of denying capital to the entrepreneur outright, the bank simply directs her to Able because we lend within a higher risk band. As the business becomes less risky over time, the entrepreneur simply refinances to a bank loan. In this equation, there’s no winner or loser — we’re simply allocating capital in the most efficient means possible, dictated by the risk of the business.
Of course, Able has fierce competition, but it’s not coming from banks. We’re competing with incumbent alternative lenders in the same way Uber and Airbnb primarily compete against their incumbents — first on price, then on user experience. Our unique lending model has made us the lowest cost non-bank lender in the nation.
Here’s to the Ableization of the alternative lending space!
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