Platforms and Partners

By Tina Orem

Lending is a fundamental franchise of the banking industry, but in the last few years a growing number of nonbank financial technology, or fintech, companies have taken a sledgehammer to that pillar. Dubbed “marketplace lenders,” these companies are building digitized, streamlined platforms and captivating investors who see a huge opportunity to turn traditional lending on its head. For many banks it’s been a startling call to action that—perhaps surprisingly—has also given rise to some innovative partnerships with those very same disruptors.

A big motivator is that marketplace lending attracts borrowers—primarily for personal loans, small business loans and student loan refinances. Three of the largest players—OnDeck Capital, Lending Club and Prosper—originated about $3.8 billion in loans in the third quarter of 2015 alone, according to SNL Financial. The landscape is getting bigger, too. According to the Federal Deposit Insurance Corporation, there were “at least three” marketplace lenders back in 2009. By last September, there were 163.

Conceptually, marketplace lending is straightforward: borrowers apply for loans online, the marketplace lender or the bank does the underwriting and the borrower gets his or her funds—usually very quickly. It’s a process that’s often faster and less expensive than traditional methods, and for many banks that’s attractive.

Today, there are generally three ways banks get into marketplace lending: build a proprietary platform in-house, form a referral partnership with a marketplace lender or license a marketplace lender’s platform. The in-house option is usually the most expensive and time-consuming but offers ultimate control over underwriting and the customer experience. Referral partnerships, whereby banks send potential borrowers to a marketplace lender’s site and either buy the resulting loans or receive referral fees, generate income and quickly fill product gaps but often come with underwriting and user-experience risks. The third method, platform licensing, allows banks to capitalize on white-labeled plug-and-play technology and nontraditional credit criteria—but it’s not exactly free and the integration requires effort.

Few banks have actually made the move to marketplace lending, according to Charles Wendel, president of Financial Institutions Consulting. Part of the trouble is finding viable partners. “There are probably—and I’m really stretching—10 to 15 companies that are capable of meeting a bank’s needs,” he says.

Nonetheless, marketplace lending is on everybody’s radar. “How many are looking at it? The answer is a lot,” he adds.

Finding the right fit
Whether to go the DIY, referral or licensing route is perhaps the biggest decision banks make when it comes to marketplace lending. But for Dan O’Malley, chief digital officer at Boston-based Eastern Bank, the decision was easy.

“Banks that outsource their lending will eventually go away,” he predicts. “We lend. That’s what we do. That’s one of the key functions of the bank. There’s no way we’re going to outsource that; it’s not going to happen. We might have to invest a fair bit of time and effort into modernizing how we lend, but we’re not going to give up lending.”

O’Malley is also the head of the bank’s Eastern Labs unit, which built an in-house business-lending platform that launched earlier this year. It took 14 months to develop, cost $5-6 million and features a five-minute loan application. He says the process highlighted a few things: banks building their own platforms should avoid outsourcing the software developers and should implement an iterative testing process, for example.

Going in-house could be too involved for some banks, which may be one reason some say the recent small-business lending deal between JPMorgan Chase and OnDeck Capital signals that partnering with marketplace lenders is a legitimate business strategy now.

“I think banks are realizing that the partnership opportunity is real with folks like us,” OnDeck’s Brian Geary says. “I think that most banks have the same problem that they’re working through: that it is inefficient to lend to small businesses under a certain dollar amount and their customer experience hasn’t really been iterated on over the past number of years.”

Creating a cultural shift
Marketplace lending partnerships aren’t just about signing contracts or writing code—missions must overlap, says Christopher Tremont, EVP of virtual banking at Boston-based Radius Bank, which partnered with Prosper last September to make personal loans.

“Prosper benefits because they get loan applications that they wouldn’t have gotten without this partnership,” he said. “At the same time, we didn’t have to go out and build a whole consumer-lending department to be able to handle the underwriting and the servicing of the loans.”

Buy-in from the entire executive team is also crucial. Tremont said that at Radius, for example, fintech deals go through the board—if they get past the chief risk officer, Tremont himself, the CFO and the CEO first. “From a strategic perspective, it became more about an investment in technology, product development and customer service for us in terms of how we were going to positively grow versus, say, a brick-and-mortar strategy where we were going to say we need to put a branch physically on every corner to succeed,” he says of the Prosper partnership.

The marketing team is also important. Tremont says Radius has focused more on client outreach and branch advertising than on Google AdWords or other digital marketing.

That marketing effort is important, Wendel adds. “If you just put in a certain lender and visual platform and don’t change your marketing, don’t change your compensation, don’t change your internal references, how are you going to get more deals?”

Investing in due diligence
Especially in referral partnerships, banks need to know what the user experience will be like, because customers perceive the marketplace lender’s platform and the bank as one and the same, warns Rob Morgan, ABA’s VP for emerging technologies. “If I send my customer to a platform that may not have the same oversight as a bank, it may not be as safe, and they may have a bad experience,” he explains. “Now I—as a bank, as the trusted provider—have sent them to something that isn’t going to do right by them. That’s a real risk.”

Understanding the marketplace lender’s underwriting process is one of the most important tasks, add Helen Sullivan, an ABA SVP who works with ABA’s Endorsed Solutions portfolio. Big data and proprietary algorithms are big in marketplace lending, she says, and banks should find out how potential partners use them. “They may or may not include everything that our bankers use when they do a credit risk analysis,” she cautions. “It’s a black box.”

Many marketplace lending companies are very young, so quizzing potential partners about their financial stability, funding, tech prowess, actual loan performance, and real-life experience with banks are musts, Geary adds.

Regulatory reckoning
Marketplace lending is in its infancy, and so is the likely associated regulatory oversight. Banks getting into marketplace lending have to be sure their platforms are compliant and can handle regulatory changes.

“You need to know that the same rules may apply to [marketplace lenders]but they don’t have the same oversight, so you need to make sure you’re really comfortable with everything they’re doing,” says Morgan. “They’re not regulated like you are, so ultimately the responsibility for your customer falls on you.”

Fintech companies also need to understand what regulators really expect. “To the extent that they are going to be partnering with banks, they need to embrace the regulators, because that’s what their clients and their future partners are going to have to deal with,” Sullivan explains.

That’s another reason banks have a big fish to fry. “I’ve had banks call me and say that they’ve lost long-term clients to some of these [marketplace lenders], because it’s faster and cheaper,” Sullivan says.

But for Morgan, these new partnerships between banks and marketplace lenders are part of a broader migration to digital channels. “Who would have thought seven years ago that I would go to my phone to hail a cab?” he asks. “I don’t think banking is really any different. What this is doing is leveraging that digital channel to meet people where they are.”

In other words, if you can’t beat ’em, join ’em.

Tina Orem is a frequent contributor to the ABA Banking Journal.