“Sorry I’m late,” says Samir Desai, “but it’s been a crazy day.”
Five years ago, Desai and two of his mates from the University of Oxford, James Meekings and Andrew Mullinger, started a crowd-funding site over pints at a London pub.
Instead of catering to cash-strapped consumers like U.S. pioneers LendingClub and Prosper Marketplace did, the trio, all now 31, targeted enterprises with at least 50,000 pounds ($81,550) in annual sales that were having trouble getting credit from British banks.
Today, Funding Circle is Britain’s No. 1 online matchmaker for small-business loans. From its inception through Sept. 25, it transacted 373 million pounds in lending between 32,000 investors and 5,000 firms, which pay interest rates ranging from 6 to 15 percent.
“Some people may still want to sit with a branch manager, but this is a game-changing way for businesses to borrow money,” Desai said.
That may sound cocky, especially considering his company’s modest volume. The small-business loan book at Santander UK, Britain’s No. 5 bank, stands at 30 billion pounds — about 80 times larger than that of Funding Circle.
But Funding Circle is leading a generation of financial technology start-ups that have just begun to challenge traditional banking’s grip on the movement of money.
Scores of fintech enterprises in London and Silicon Valley are devising new ways to lend cash, transfer money abroad, settle international commercial transactions and score credit risk — all of which have been the domain of banks for centuries.
“Prior to 2008, it was accepted wisdom that if you didn’t have a banking license, a massive balance sheet and a 300-year-old name, you couldn’t possibly play in this space,” said Neil Rimer, co-founder of Index Ventures, which has invested in more than two dozen fintech firms in Europe and the United States, including Funding Circle. “But after trust in banks crumbled during the financial crisis, that emboldened entrepreneurs to start companies and go after them.”
The fintech generation promises to harness the Web to create a faster, easier, more-efficient way for consumers to bank.
One key tool: the online marketplace model pioneered by auction powerhouse eBay. By matching lenders and borrowers on a Web site, Funding Circle can originate a loan for a small business in three weeks or less instead of the months it can take at a conventional bank.
While almost 40 percent of the small companies that sought loans from traditional British lenders were turned down in the second quarter of 2014, according to the Federation of Small Businesses, 100 percent of Funding Circle’s applicants obtained credit from investors.
Betting that global banking — with $50 trillion in assets — is ready for a historic shift, investors are piling into fintech start-ups.
French telecommunications billionaire Xavier Niel and PayPal co-founder Peter Thiel are backing TransferWise a London-based online marketplace that moves money internationally for 10 times less than conventional banks.
Google’s venture arm has invested in Upstart Network, a peer-to-peer firm based in Palo Alto, Calif., that uses unorthodox measures such as college grade-point averages to assess the credit risk for recent graduates.
Even old-school bankers are joining the revolution: John Mack, former chief executive of Morgan Stanley, sits on LendingClub’s board, and Richard Kovacevich, former chief executive of Wells Fargo, is an investor in Daric Corp., a crowdfunding venture based in Redwood City, Calif.
With terms of less than five years and average net yields of 9 percent in a zero-interest-rate market, peer-to-peer loans have become desirable fixed-income bets, said Cormac Leech, an analyst at Liberum Capital, a London-based investment bank.
In London, the world’s No. 1 international banking center, new ventures are materializing every month in the hipster haven of Shoreditch as angel investors and venture capitalists pour money into British fintech firms at twice the clip for those in Silicon Valley, Accenture said.
“Banking is ready for massive disruption,” said Taavet Hinrikus, TransferWise’s co-founder, who was the top employee at Skype Technologies in a previous life.
Fintech has a powerful ally in U.K. Chancellor of the Exchequer George Osborne.
In speeches and policy statements, Osborne has expressed his frustration with Britain’s Big Four — HSBC Holdings, Barclays, Royal Bank of Scotland Group and Lloyds Banking Group — for squeezing credit to small and medium-sized companies.
In the first half of this year, net lending to enterprises with less than 25 million pounds in annual sales shrank by 1.3 billion pounds even though the Bank of England has bestowed banks with cheap capital through its Funding for Lending Scheme.
In August, Osborne introduced legislation that would require lenders to refer borrowers they reject to peer-to-peer firms and other alternative providers.
“People are using technology in new ways to communicate, to form social groups, to shop — why not new ways to bank?” Osborne said in an August speech.
“It means being able to bypass traditional banks altogether and lend money directly through peer-to-peer platforms like Funding Circle and Zopa,” a nine-year-old firm that pioneered the model.
It’s going to be tough to disrupt an industry as entrenched as banking. In the United Kingdom, the Big Four control 80 percent of the lending market.
“I’m positive about this financial innovation, but there is a little euphoria going around,” said Thorston Beck, a professor of banking and finance at City University London’s Cass Business School. “If this really expands at a rapid speed, then more-marginal companies will get loans, too. So we have to be realistic about questions of scale and risk.”
Banks themselves are moving to co-opt the fintech surge. In December 2013, Barclays joined forces with Techstars, a U.S. and European accelerator, and started the first in a series of three-month boot camps that will help start-ups develop business plans. And in July, Santander UK, a subsidiary of Madrid-based Banco Santander SA, created a $100 million fund to invest in fintech ventures worldwide.
“We’re good at assessing credit risk, but the whole idea of innovation isn’t a natural skill set for any large bank,” said Steve Pateman, Santander UK’s head of banking. “So we want access to different ideas, and we’ll seed those that give us more options to expand our business.”
In 2009, Desai was watching the fallout from the global financial crash with a sense of opportunity. Desai, who studied economics and management at Oxford, specialized in the inner workings of banks at Boston Consulting Group and Olivant Advisers, a London-based private-equity firm.
He saw how small businesses were paying a price for a crash not of their making as wounded lenders withdrew credit.
That August, loan approvals to small and medium-size companies fell 13 percent. Desai said he wondered: What if someone used an online marketplace to provide these borrowers with an alternative?
Brainstorming at a London pub, he, Meekings and Mullinger noted that large companies could tap the fixed-income market to raise capital. So they hit on the idea of using a peer-to-peer approach to form a virtual syndicate for more-diminutive enterprises. “We wanted to create a bond market for small businesses,” Desai said.
To do so, they had to establish a secondary market where lenders could trade the loans the same way bondholders do, Mullinger said. Otherwise, investors would be loath to fund debt they couldn’t sell.
“For this to work, we had to provide liquidity,” Mullinger said. “Without that, I wouldn’t put any money in it myself.”
The three men formed Funding Circle in September 2009. Over the next year, they set up a risk-analysis system that grades borrowers using at least 400 bits of data, such as credit-card-payment history and legal judgments.
They established a Web site where lenders scroll through a menu of potential borrowers. Funding Circle charges borrowers a 2 to 5 percent fee and lenders a 1 percent annual rate. Like bondholders, the investors receive a coupon-like payment; as of Sept. 8, their average net return was 6.4 percent.
Those investors lend money to companies such as Kaizen Furniture Makers, a 35-employee firm.
When company co-founder Antonius Wubben decided in 2013 that Kaizen needed a state-of-the-art Austrian hydraulic press to apply veneer to pieces of wood, he posted a loan request on Funding Circle’s Web site. Less than three weeks later, 612 investors had ponied up 100,000 pounds at a 9.1 percent interest rate. Now those investors are trading Kaizen’s debt on Funding Circle’s secondary market, which handles about a fifth of the site’s total loan volume.
In less than five years, Desai and his partners have set up a lending alternative that’s growing so fast that they’re desperate to find more office space to accommodate all their new hires. Funding Circle has raised $123 million in venture backing from Index, Accel Partners, and Union Square Ventures, the same outfits that backed Skype and Facebook.
Because of the Web, they’ve done so without the costly branch networks and capital requirements that burden commercial banks.
Funding Circle and its online peers are originating loans for 40 percent less in costs than traditional lenders, said Leech of Liberum Capital. With a 1.4 percent default rate, Funding Circle has demonstrated that it can manage risk, he said
Even so, Funding Circle has far to go. It isn’t expected to record a profit until 2016, according to a forecast by Leech.
Desai has big plans. Funding Circle, which late last year began expanding into the United States, plans to push into asset-backed lending and property development debt. Asked if the inevitable next step might be an outright acquisition by a bank, Desai laughed.
“If they can afford us,” he said.
The full version of this Bloomberg Markets article appears in the magazine’s November issue.