Dr Holger Kern: Microfinance - An urban Myth or Rural reality?

How microfinance exchanges like ZOPA, Lending Hub, Prosper, Smava and Boober threaten banks.

Favored by banks and other lending institutions in emerging and frontier markets, micro-financing traditionally focused on helping rural clients create goals-based assets and liabilities. The main players in this area have been banks and non-governmental organisations backed by credit issuing non-banking financial institutions targeting both individuals and communities. In an era of low cost funding, micro-financing, in the primary and secondary markets, has caught the interest of various financial institutions looking to create more diversified portfolios.

Although micro-financing is successful in rural markets, financial institutions have not bothered to transfer this format to other market segments, mostly neglecting the urban individuals / communities. This void lead to the development of money exchanges such as ZOPA, Lending Hub, Prosper, Smava or Boober. How long can banks afford to ignore this disruptive innovation? Not only do online micro-finance exchanges fill a void by allowing people to lend and borrow, the online services have huge cost advantages that pose a big threat to the established banking scene.

Hopefully banking will learn a valuable lesson from the telecom sector, another asset-intensive industry. Telecoms tried ignoring VoIP services for fear that they would lose their traditional voice revenues. However, they soon realised they couldn’t neglect the disruptive innovation created by VoIP service providers such as Skype and eventually began launching their own VoIP services to maintain their customer base. This has been a hard lesson not only for telecom companies but also for other asset-intensive industries such as airlines that have been unwilling or unable to innovate.

P2P micro-financing is a great business opportunity for banks providing them with an opportunity to thwart potential threats from online exchanges and increase their fee-based income. Banks have one big advantage over online exchanges – they have a keen understanding of the various risk profiles of borrowers. This knowledge and their present client base of both borrowers and lenders make it easy for them to launch P2P micro finance. The revenue model needs to ensure that the direct cannibalisation would lead to a potential increase of total revenues – not only through fee-based income, secondary market revenues, wholesale micro finance, but also through direct selling of additional products.

As social lending sites continue to attract customers that are being ignored by the major institutions, the number of users will continue to rise, eventually attracting traditional bank customers who will help make this form of borrowing (and lending) mainstream. With the overhaul of the banking industry, now is the time to add services that take advantage of the banking industries strengths. Micro-financing is not just for the third world – it is for the web 2.0 world.