Alternative Financing: Why people are moving away from big banks when borrowing money?

With the rise of the digital era a whole array of competitors have joined the banking sector, and at an unprecedented level. From funding new ideas with Indiegogo and Kickstarter, to personal loans from GiffGaff and Zopa, customers have far more options today than they did ten years ago, and they’re banking decisions reflect that.

Traditional banks shouldn’t be trying to compete with the alternative financers, but should show their value as an established and adaptable company. This means fully engaging with customers in the digital world, and providing a more thoughtful service by utilising their wealth of data and experience.

A New Type of Customer

In the modern world, when a person wants to borrow money, they no longer pour through public reports or seek an advisor to get information and guidance on where, what and how to borrow. The internet has created a smarter customer and more opportunities for alternative financing. Pair this with low trust in banks and a very simple process, alternative finance is becoming a strong competitor to traditional funding, lending & investment.

How It Started

Indiegogo and Kickstarter were established 7 years ago, giving small business and start-ups access to cash to bring their projects to fruition. Rather than receiving dividends in return, the backers receive rewards such as the product/film/music being developed and other exclusive products, which are often posters, t-shirts and other memorabilia, all dependent on the amount they decided to pledge. Not only do the founders have the funds they need, they also have the confidence that there is a market to sell to.

Since its launch in April 2009, 9.7 million people, from every continent on earth, have backed a project on Kickstarter. $2 billion has been pledged, and 94,241 projects have been successfully funded. Indiegogo has over 7000 campaigns active at any given time, and shows no signs of this alternative financing revolution slowing down with a 1000% increase in funds raised in the past two years.

In an interview with The Guardian, co-founder of Indiegogo explained that creative people “were completely dependent on a third party investor, a gatekeeper, someone whose interests were not aligned with theirs to unleash that.” By making the audience the investors, they created an open, gatekeeper free system.

These alternative financing options aren’t a risk-free way of lending and raising money though, and there have been some newsworthy issues. Torquing Group, a British based start-up, raised £2.3 million for their Zano drone on Kickstarter. After shipping just 4% of their obliged sales from the crowdfunding site, Torguing Group went bankrupt and gave no explanation to Kickstarter or the backers. Although, not a great endorsement, we have to remember that most start-ups do fail, and that risk is still involved in this kind of investment.

From Small Business to Personal Loans

So creators took the first step, but now we’re seeing a surge of alternative financing organisations, offering loans and mortgages to the public. You may have even heard of a few: Lending Club, GiffGaff and Zopa.

Zopa, established in 2005, is the UK’s largest alternative lending organisation, and have lent over £1 billion to over 110,000 people, with over 59,000 lenders. They aim to offer their loans to people who are “good with money”, and offer in return low rates and no early repayment fees, which can be paid back over one to five years. An easy to use website, with a quote that won’t affect your credit score, makes lending more accessible and often much more beneficial to the borrower.

Not Only the Borrowers Benefit

Let’s not forget that there are two sides of alternative financing. While people are able to borrow money, there are thousands of people investing their money in this new area and making strong returns from it. Lending websites make the process a simple procedure, making it a very accessible investment option for people who may have traditionally been ambivalent about such processes.

Crowd Mortgage has set up an investment firm where people can save/invest their money in mortgages while receiving an average return rate of at least 5%. They give you full control of where your money goes, and a return on your investment is guaranteed, so people can feel secure that they won’t lose money.

Why Do Some People Prefer Alternative Financing?

Sparked by the financial crisis of 2007/08 increased access to information thanks to the internet, a lot of people have lost trust in banks. A YouGov-Cambridge study “Public Trust in Banking” found that “Just 4% [of those surveyed] reckon banks observe high ethical and moral standards … and just 17% of us trust the people running British banks to tell the truth”.

Banks have now realised how this is becoming a more prevalent problem, and aim to become more personable, but their efforts need a boost, especially when you look at what other sectors are doing. Big organisations such as Tesco, Virgin Trains and more, have utilised their social media presence to interact with customers in a less formal manner, and where appropriate add a humorous touch for a more human interaction.

Barclays and Citi have taken some first steps in the right direction, providing non-financial advice to people for free, as a means to improve their brand image. Increased engagement can improve perception, but with so many comparison sites flooding the market, the best deal is easy to find and with no need to talk to an advisor when switching, there’s no hesitation for a customer to move to the better offer.

What Can Banks Do?

Is it too late for banks? Is this the future of lending? Not anytime soon, but it’s definitely gaining a significant portion of the market, with the market share of alternative financing rising by 161% between 2013 and 2014 according to the Nesta Understanding Alternative Finance Report 2014.

Maybe we’ll see banks create their own alternative financing platform, using their experience and brand, but with less of the risk on their back. Whatever they do, they’ll need to keep up with the new digital world we’re entering, by becoming smarter, more creative, in the way they lend money.

Five things banks need to do to make sure they don’t get left behind:

1. Understand each customer, not your average customer. You have to be a different bank to different people. Banks are in the unique position of knowing what their customers are buying, doing and where they are in the world, and yet they don’t use this information fully to their advantage. Using big data and analytics to understand to create unique images of each customer.
2. Go to the customers at the time they need them. You can paint a picture of your customer and predict whether they’re going to be in the market for car insurance, re-mortgage their house or need to consolidate their debts. Marketing the right people at the right time will be more effective at selling new products.
3. Regain trust. Obvious, but important, banks need to become much more personable than they have been in the not so distant past. This is a two way street, you understand your customer better, but they need to understand you now. Applying digital customer experience transformation, banks can modernise their approach to interacting with existing and potential customers.
4. Be digital. A vague statement, but an important one. This doesn’t mean put out a basic mobile app and rest easy that you’re a modern bank. You’ve got to keep up with new technology, even be ahead of your competitors to engage your customers in new ways and make banking with you, the easiest it possibly can be. If you don’t do it, someone else will.
5. Be more than just a lender. Give the customer more resources; more tools to better manage their money, so they get more value from you as a provider. Break downs of expenditure, tips for saving money, offer services that could be beneficial based on their actual activity. Do the hard work so that the customer doesn’t have to.