Fin Tech as a Disruptor of Financial Services

1. Reena Aggarwal Robert E. McDonough Professor of Finance Director, Georgetown Center for Financial Markets and Policy FinTech as a Disruptor of Financial Services Disruptive Innovations in Financial Services Institute for Financial Services Analytics Alfred Lerner College of Business & Economics University of Delaware March 2016

2. Disruption in Financial Services • Address societal challenges • Financial inclusion • Inequality issues • Access to capital • SMEs • Our work with the World Economic Forum/World Bank

3. •FinTech: Use of technology and innovative business models in financial services •Companies provide financial services through the use of technology – These companies provide products and services to users through online and/or mobile channels FinTech Characteristics Innovation •Innovative solutions have disrupted the traditional financial services industry •Promises to include un-served and under-served markets •Have increasingly provided funding for SMEs especially after the Great Recession •Face lower costs Focus Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 •Single-purpose solutions: Offer a better experience in a single product or service •New sets of products: Tailored for small businesses FinTech as a Disruptor of Financial Services Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor

4. Factors Enabling the Industry’s Growth Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Regulation Regulated banks face higher costs for lines of business FinTech firms are tapping into Technology Macro Environment Big data analytics increasingly available Online financial transactions, alongside big data analysis, have lowered costs and increased speed Low interest rates and low loan default rates allow for credit creation; the former has increased the demand for loans while the latter has increased investors’ willingness to lend Investors are seeking assets with higher yields & are comfortable with higher risk profiles of borrowers Risks 1. Limited investor protection 2. Defaulting borrowers 3. Systemic risk associated with lack of regulation

5. The Growth of FinTech Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 • Reduced the availability of credit for individuals and small businesses • Triggered regulations that have since hampered traditional banks’ ability to meet the needs of SMEs, among others • Big opportunity for FinTech firms Great Recession 2007-2008 2005-2011 2013-2014 2015 New players emerged: • Prosper (2005) • Lending Club (2006) • OnDeck (2006) • Kabbage (2009) • SoFi (2011) New Players Investment in FinTech companies grew by four times in one year, reaching $12 billion in 2014 Threat to Banks • 68% of bank respondents believe their small business lending activities were under “high threat” from FinTech firms Growth Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor

6. Factors Enabling the Industry’s Growth Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Approval Rates for Small Business Loans 0% 10% 20% 30% 40% 50% 60% 70% Alternative Lenders Institutional Investors Credit Union Small Bank Big Bank

7. 0% 10% 20% 30% 40% 50% 60% 70% Millennials Gen X Boomers Matures Millennials Prefer Online and Mobile More than Other Generations Online Giving Mobile Giving FinTech as a Disruptor of Financial Services Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Facts Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor Mobile P2P payments in the U.S. reached $16bn in 2015 and are estimated to reach $86bn in 2018 P2P loan issuance grew by 65 times from 2009 to 2014 on Lending Club and Prosper, reaching $1.7bn Non-banks’ share of mortgage originations went from 10% in 2009 to 42% in 2014 60-80 countries already have a lending platform or one expected to launch soon

8. $1.5 $2.7 $5.1 $10.0 $0.0 $2.0 $4.0 $6.0 $8.0 $10.0 $12.0 2011 2012 2013 2014 FundinginBillions Year Aggregate Amount of Funding Through Crowdfunding FinTech as a Disruptor of Financial Services Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Facts Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor Kickstarter crowdfunding platform has reached $1.6 bn in pledges alone, its largest campaign raised $17+ million

9. The Growth of FinTech Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 0 2 4 6 8 10 12 14 Year 2013 Year 2014 InvestmentinBillionsofUSD Investment in FinTech Firms 27% 16% 57% Breakdown Consumer Lending Business Lending Others Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor

10. Lending Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Business Models Models: • Balance sheet lenders • Marketplace lenders • Hybrids Focus on: • P2P lending, Small business lending, Leveraged lending, Student lending, Mortgage lending, Commercial Real Estate Lending Key Characteristics • Unsecured lending • Either mediated or direct flow of funds • Retail or institutional investors • Innovative credit scoring models • Low cost structure and more accurate pricing • Less regulatory obligations and capital requirements than bank counterparts Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor Practice of lending money to borrowers without traditional financial intermediary

11. Market Segments, Business Models, and the Main Players Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Lending Merchant and e-Commerce Finance Invoice Finance Supply Chain Finance Trade Finance

12. Lending Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Lending Club and Prosper had 129% CAGR in collective originations 4Q09 to 3Q14 Main Players Description • P2P lending platform founded in 2006, IPO’d in 2014 (LC) • Biggest player, yet only has 2% of market share ($4bn in $240bn market) • Founded in 2005, focuses on P2P lending and remains private • Took 8 years to reach first billion, only six months to reach second • Founded in 2006, focuses on business lending • Quarterly origination volume grew from $61mn/qt in 4Q12 to $313mn/qt in 3Q14; currently has $433 million in loans outstanding • Founded in 2011 • Offers refinancing options for students • No residual risk on originated loans

13. Lending Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Enablers for Growth • Data availability • Supportive regulation • Risk-taking investors • Educated borrowers • Effective platforms • Third-party service providers • Socialization of finance Risks Outlook • Investors’ lack of experience • Making access to capital too easy • Sustainability and stability still to be tested • Systemic rick arising from unregulated sector; regulation likely to increase • Millennial small business owners are 5 times more likely to use P2P lending than Boomers • Consolidation • Internationalization of payments • Industry formalization Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor

14. Lending Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor How Does it Work? Lending Club Partner Bank (not owned by lending platform) Investors, banks, institutional whole loan buyers Borrowers (1) Application (2) Commitment (5) Cash (9) Loan Note (8) Origination Fee (6) Cash (7) Loan Note (4) Loan Note (3) Net loan proceeds

15. FinTech Firms in Lending Benefitted from Changes in Regulation Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Changes in regulation are driving businesses out of traditional banking system and into new players Lending Product Regulation Impact Opportunities Personal • CARD Act • Stricter capital requirements Diluted returns for banks from higher capital requirements Increased credit card interest rates Non-banks not subject to higher capital requirements Can price below banks Small Business • CCAR • Focus on concentration and pricing Regulated banks unable to price risk in lower credit loans Non-banks can change to higher rates on loans with higher risks Leverage • OCC Guidance, “Skin in the game” rules for securitizers, CCAR Regulated banks unable to take on riskier deals Non-banks tap into riskier deals Commercial Real Estate • Basel III • CCAR Diluted returns for banks from higher capital requirements Other lenders can tap into more complex deals Mortgage Banking • Basel III, Home Mortgage Disclosure Act, Qualified Mortgage rules for underwriting, “Skin in the game” rules for securitizers Banks have to sell MSRs and decrease number of mortgage originations Non-banks have doubled their market share in mortgage origination Student • More oversight by CFPB, 2010 elimination of FFEL loan program, possible student loan bankruptcy reform Big banks stopped originating student loans, divesting into run-off portfolios Marketplace lenders’ business model focused on refinancing student loans at lower rates Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor

16. Lending Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Market Overview Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor FinTech lending platforms accounted for $60-70 billion in outstanding loan volumes in 2014 Loans worth $40 billion in China and $5 billion in the U.S. Total addressable unsecured consumer loan market estimated at $270 billion, out of which Lending Club and Prosper, the two largest players, have 1.8% market share

17. 0 2000 4000 6000 8000 10000 12000 14000 Crowdfunding Wealth Management Payments Unsecured Personal Lending Small Business Loans Student Loans Annual Loan Origination of Mortgages Market Size (bn) Immediately Addressable (bn) Factors Enabling the Industry’s Growth Sources: “The Future of FinTech: A Paradigm Shift in Small Business Finance” World Economic Forum. Oct, 2015. and “The Future of Finance” Parts I-III by Nash, Ryan and Beardsley, Eric. Goldman Sachs. March 2015 Broad Opportunities Millennials are 5 times more likely than Boomers to use P2P lending for their small businesses HENRY’s: Tapping into under-served markets, the High Earners, Not Yet Rich Business Models Market Segments Going Forward Major Players Growth FinTech Disruptor $4 trillion of immediately addressable revenue in the socialization of finance sector 50% of Millennials believe tech start-ups will overhaul banks 33% of Millennials believe they will not need a bank in 5 years and only 50% expect to use cash on a weekly basis by 2020

18. Risks Going Forward • Regulatory Response as FinTech firms become large • Funding Sources • Lending Laws • Operational Structure – technology risk, data protection, relationship with traditional banks • Incumbent banks will respond – JP Morgan & OnDeck • Consolidation

19. Regulatory Uncertainty Going Forward China People’s Bank of China: Online Payments China Banking Regulatory Comm: Peer to Peer (P2P) China Securities Regulatory Comm: Crowdfunding China Insurance Regulatory Comm: Online Insurance

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