Nearly every American interacts with a bank, or credit card company, using it regularly for purchasing items both online, and in person, and even securing personal and business loans.
While banks have seemed to control the lending space, more opportunities are arising, which in turn disrupt traditional lending as we know it. Not only is virtual currency becoming more popular, creation of options like Bitcoin might be a simple stepping stone into what's lying around the corner, waiting to take control of the space.
A full transcript follows the video.
Kristine Harjes: Disrupting the financial sector as we know it. This is Industry Focus.
Hello, hello! Happy Monday, everyone. I'm Kristine Harjes, and this is Industry Focus financials edition. I'm joined today by John Maxfield, The Motley Fool's senior banking specialist calling in from Portland, Oregon. John, welcome back to the show.
John Maxfield: Thank you very much, Kristine. I appreciate it.
Harjes: Glad to have you here. So, first off, for any of our listeners out there who just graduated, or are about to: congratulations and welcome to the "real world". First quarter of 2015 marked a milestone for the workforce as it was the first time that millennials passed generation x-ers. So, millennials are your 18 to 34 year olds as of 2015, and gen x is defined as ages 35 to 50.
So, we've officially got more millennials than gen x-ers. For reference the millennials actually passed the baby boomers, which is your age 51 to 69 in terms of workforce representation last year. So, they're the biggest out there and we've got a whole new class of young people joining that. If this generation is known for anything, it's technology and disruption.
We've seen it in content distribution, a la Netflix (NASDAQ:NFLX), retail through Amazon (NASDAQ:AMZN), and now we're seeing it in the world of finance. So, we've got a couple of different categories that we wanted to dig into today to introduce you guys to all the different areas of "fin-tech" and what exactly to look for in terms of up and coming technologies and apps and how we can anticipate this world changing. And it is changing rapidly.
So, let's dig right in. Let's say the first category that we want to dig into would be your lending services. John, I'm going to hand this off to you to talk a little bit about different disrupters in the field of lending services.
Maxfield: Sure. Traditionally the way this worked is that, if you needed a loan, you needed capital to either buy a house, buy a car, whatever it is -- or start a business -- you'd have to go to your bank, and you'd go through that arduous process of getting your credit checked, going through your income statements, your balance sheets and all those various things. Then if everything worked out you'd get a loan and then a month, or couple months, you'd move down the road.
Well, now what these companies are doing -- these are companies like Funding Circle, LendingClub (NYSE:LC); those are two of the big players in the industry. They are taking the middle man, so to speak, out of the equation and they're just connecting investors -- institutional investors, individual investors -- with people who need to borrow money.
So, let's say, Kristine, that you needed a loan to buy a BMW. You really want to go all out and impress your friends. You want to buy a BMW, and you need $50 thousand to do that. Well, you could go onto Lending Club's website and request a loan for $50 thousand and then individuals like me that have excess money, I can then fund that loan, and then you would pay me interest rates, as opposed to you going through a bank.
Harjes: So, would you be the one determining that interest rate?
Maxfield: I wouldn't be the one determining that interest rate. Lending Club, Funding Circle; they do all the work behind that, but they would present the opportunity, present the interest rate, and then I would agree whether or not I believe that was a good investment.
Harjes: So, we've got different ways of making personal loans. There's also alternatives to banks for small business loans. You've got companies like On Deck (NYSE:ONDK) and I actually saw this morning, digging into my research for this episode for you guys, Goldman Sachs (NYSE:GS) research says that in January of 2015, alternative lenders generated 62% of all small business loans.
Maxfield: Wow. I did not know that. That is an incredible statistic. One of the things that would be interesting to see is, what they include in the category of alternative lenders. My guess -- by the sound of that statistic -- is that it goes beyond these younger, start-up fin-tech companies. But, make no mistake about it, this is a very disruptive technology and it's something that's picking up a lot of steam.
If you look at Lending Club, you have two people on their board. You have John Mack, who's the former Chairman and CEO of Morgan Stanley (NYSE:MS). This guy knows what he's doing in the financial industry. You also have Larry Summers, former treasury secretary, former chairman of the economic council of economic advisors. So, you have a lot of people who come from finance who believe deeply in these technologies.
Harjes: Exactly. So, the next category I think we should touch on would be banking services. We had, first off, was our lending services, now let's talk a little bit about banking services. What are some of the names that are disrupting in here?
Maxfield: The big name in the banking services space -- and just be clear, what we're talking about with 'banking services', these are fin-tech companies that provide debit accounts, effectively at this point. They haven't expanded much beyond that. So, it's your personal checking account that you can access with a debit card.
So, your biggest and most advanced player in this space right now is Simple, which was purchased last year by BBVA (NYSE:BBVA) which is a Spanish banking conglomerate. You also have Moven and Digit. What these companies do is, not only do they provide the actual personal checking account, but they provide a really sleek interface -- user interface -- that you can use on your mobile phone that is designed not just to show you what your account balance is and your transaction history, but to actually help you make better decisions in your financial life.
I like to think about it -- it's like the financial equivalent of a Fitbit, or a step tracker. Where a company like Moven is coming in and they track your spending and they will show you on your pone, each time you make a purchase, where your spending is at on a daily basis, relative to your average day, and on a monthly basis, relative to your average month.
So, this basically helps you keep your financial life in order.
Harjes: I love that reference, as an avid Fitbit wearer. So, I'm also going to throw a couple more out there just because they're things I could pull up on phone right now that I personally use. Mint is a good way of tracking your different expenditures, and then there's also Venmo, which is something that I personally use to pay my rent. It's a money transfer system.
So, that's another super convenient one. So, third category that we want to talk about for these different types of fin-tech disrupters would be your Robo-Advisors. Your people that are disrupting the traditional world of financial advisors where you go in and you talk to somebody, you have some relationship, you go out golfing, you take your other dog -- hopefully they take care of your dog, actually.
So, now you have technology that's coming in and trying to displace this traditional advisor relationship.
Maxfield: Yeah, and this is something that we've talked about a lot in the past, is the behavioral things that impact people's investment decisions. What these companies are doing, they're doing the same thing that the fin-tech companies and banking are doing. They're trying to provide services and solutions to financial issues in your life. In this case -- in the context of investing -- you have companies like Betterment who are coming in and saying "We know that investors, as a general rule" -- and this is everybody.
This is me, this is Kristine, this is everybody with the exception of Warren Buffetts, and your Charlie Mungers. "We make decisions based on emotions and based upon impulses that, in the investment world, do not produce maximum returns."
So, Betterment is coming in and they are automating that whole process to make it, not only easier for you, but to generate better returns. Basically, all you do -- it's just a brokerage company --but you access it either online, or through your app. You put the money in there, you layout a couple of different scenarios -- what you're saving for, how much you want to spend at the point that you get there, like retirement --and then it takes those things into consideration and spits out a portfolio that you should be following and then it updates that as you go along.
Harjes: That's all algorithm based, it totally takes the human emotion out of there.
Maxfield: That's right. And that is an extremely important thing when it comes to investing. If there's anything that we've learned over the past decade from what's going on in behavioral finance, and behavioral economics it is that we have a tendency to buy high and sell low, and that's all because of the fact that when everybody else is greedy, we get greedy and buy, and when everybody else is fearful we get fearful.
And that translates into absolutely horrible investment returns.
Harjes: And people are starting to pick up on this concept, too. Another big name in this space is Wealthfront. So, between Betterment and Wealthfront, they have $3 billion in assets under management. So, that's pretty substantial. Interestingly, Wealthfront is just a manager and doesn't actually hold the money itself.
Apex Clearing Corporation actually holds the portfolio. This brings up an interesting point, where a lot of these companies are not necessarily displacing banks themselves. They still actually need to rely on a traditional bank and they're building on top of the banks to try to improve their services.
Maxfield: Yeah. The way that one of the executives put it to me, he said "These are user interfaces. A lot of these are user interfaces that are built on top of a banking, or a brokerage chassis." Which brings up a whole new assortment of questions. You have to wonder, if you're just adding on top of banking services, or you're adding on top of brokerage services -- and not all the companies do that. Some of them, like Betterment, it's both brokerage and the user interface.
But with these other ones, you have to wonder: are those added expenses going to make this unprofitable enough that some of these, at the end of the day, will be non-starters.
Harjes: So, I will transition to our last category here. That is your payment people. John, what do we mean by that?
Maxfield: In the payment space, traditionally when we think about payment space you're talking about your Visa (NYSE:V), your MasterCard (NYSE:MA), your American Expresses (NYSE:AXP); basically the people who -- the companies that are handling when I go to a store and I make a payment with my credit card, they're the ones acting as a liaison between me, my bank, and the retailer. They're getting that data from one place to another. They're guaranteeing those transactions. They're acting as a clearing house; things like that.
We've seen a lot of disruption in the payment space -- Square is probably the leading company that comes to the forefront of your mind. So, this is a company that they just provide an app and then the little hardware device that retailers -- particularly small retailers -- can attach to an iPhone, or an iPad, or some other mobile technology, and then run your credit card. Then that will handle the whole transaction, bypassing Visa, MasterCard, and American Express.
Although they use the same underlying infrastructure. So, this is really important. You also have your Bitcoin and that whole thing, which I suspect you'll talk about here in a little bit because I know it's of interest to you. But payment space is really, really vulnerable to disruption because the amount of money that these companies are making in the interim -- your Visa, and MasterCard, your American Expresses -- is absolutely enormous.
So, you're going to have some of these start-ups come in and want a piece of that, and we're seeing that with companies like Square and people who are getting in on the Bitcoin revolution.
Harjes: Yeah. You hit the nail on the head there. I think this, of all the spaces, is poised for the most significant disruption. I want to go back to Square really quick because one interesting thing about them that I want to talk about is, their Square Capital ARM, where they also offer cash advances to small businesses.
So, these are different than your traditional loans because they're not as heavily regulated, they're riskier, and thus more potentially expensive for the recipient. But these guys advanced $25 million in April. So, the repayment of these cash advances is the part that I think is the most interesting portion of this story.
It comes directly out of a percentage of the future sales that these businesses make using Square. Square itself says it will take more money out of the business if the business is doing well, and less if the business is struggling. So, super interesting model right there.
Maxfield: Let me just make one quick point about these lenders, and Lending Club. These are really innovative approaches. There's not question about that, and this is the direction that financial services is going. However, the one thing you have to keep in mind is that you never know how well a lending portfolio is going to perform until you have a downturn in the credit markets like we had back in the early '90s, like we had during the financial crisis.
Although, we're not going to have one as deep as the financial crisis, hopefully for many, many decades. But that is when you actually know how well these lenders are going to perform over the long run. So, it's kind of a 'wait and see' for the time being. But certainly, this is an area -- lending in particular -- that I can't help but think is going to take off.
Harjes: So, along those lines you also mentioned Bitcoin. There's this big question out there: is Bitcoin going to be the next big thing? Is it going to disrupt traditional currency and blow credit cards out of the water? This is something I've given a lot of thought to, and I do think that we're going to see a digital currency have a much larger role than it does currently.
But I don't think it's going to be bitcoin. I think Bitcoin itself, structurally, couldn't handle the volume of transactions that traditional credit cards see. But part of me does suspect that there's going to be a better version of Bitcoin that will come in and be truly, truly disruptive. That kind of brings me back to the point of this episode, which is: which of these technologies actually stands to be totally disruptive the way that Amazon was to retail?
John, what do you think? Of all the ones that we've talked about -- or maybe one we haven't talked about yet -- what do you see as having the biggest potential for disruption?
Maxfield: Yeah, I would agree with you. I think it's payments. I say that because that is a wholly new concept. Not wholly new concept, but a totally new approach to the concept with Bitcoin, as opposed to your Visa, American Express. Totally different. That's the type of thing that transforms an industry.
When you look at your banking providers in the fin-tech industry, again, these are providing customer experiences built on top of a chassis, in the same case with some of these brokerages. Those are more variations on a theme, whereas once you see that dominant player -- whoever that's going to be in the payment space, or the digital currency space, and those are kind of one in the same -- that is going to be the one that is truly disruptive. At least in my opinion.
Harjes: Yeah. So, you're implying that there's going to be a huge network effect, and some distinct advantage for that first mover?
Maxfield: I certainly wouldn't be surprised if that would be the case. It's interesting. We haven't seen the network effects yet around Bitcoin being the first mover, but I think that once somebody -- to the point you made a little bit earlier -- once somebody figures out how to scale that up to a sufficient size that it can handle the volume of transactions that are necessary to handle on a global basis, or even on a domestic basis -- whoever figures that out will have proverbially the 'key to the kingdom'.
Harjes: Yeah, definitely something to keep an eye out for. It'll be really interesting to check back in a year or so and see if any of these 2015 graduates have come up with that key. But for now, I guess we're just left speculating, keeping tabs on what's out there, downloading some of these apps and testing them ourselves, seeing what it is that could be the next big thing.
So, for that I thank you so much, John, for giving us all of these different names and insights into what's going on in the fin-tech sphere.
Thank you listeners for tuning into us, as always. Until next time, have a great week everyone.
As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against. So, don't buy or sell stocks based solely on what you hear.