Modern Money: How the Banking Crisis Opened the Door for Internet Start-ups

Visionaries from Wonga.com, FundingCircle.com, TransferWise.com and Index Ventures discuss the issue of 'Modern Money'.

"Banks have done a good job over the decades of making us feel like they are doing us a favour by looking after our money."

"For businesses lending money is a very emotional thing and they have to be very reassured."

Is banking the next industry to feel the squeeze from online services? If you speak to the people running a new breed of web start-ups, the global financial crisis is not the only thing they have to worry about.

"Financial services over the next 10 or 20 years will undergo the same type of revolution that telecoms experienced, that media has experienced recently," Errol Damelin, founder and CEO of Wonga.com, told a discussion hosted by the Albion Society.

"In that the existing models of delivery and its models of engaging with customers become bankrupt much more quickly than people expect them to."

Bankrupt is not a word financial institutions want to be associated with, yet it is one that has been all too familiar in recent years.

That Damelin uses bankrupt to talk about a failing in the banks' relationship with their customers, rather than an emptying of their coffers, is telling indeed.

Damelin was joined in discussion by Samir Desai, CEO and co-founder of FundingCircle.com; Taavet Hinrikus, co-founder of TransferWise.com; and start up investor Robin Klein of IndexVentures.com; as well as Albion CEO Jason Goodman.

The panel believed that trust in financial institutions is at such a low point that it has created tensions between the banks and the people who used to happily hand them money.

"Banks have done a good job over the decades of making us feel like they are doing us a favour by looking after our money. This attitude manifests itself in policies that are stacked in the banks' favour," said Goodman, who suggested this was a reversal of how it should be since banks rely on customer deposits so they can lend money to others.

A number of internet start-ups have emerged in the face of this dissatisfaction and they are slowly beginning to challenge the traditional role of banks.

Desai said that FundingCircle.com had used this change in the status quo to create a peer-to-peer lending service where regular people fund business loans.

"In the UK 90 percent of all lending to small and medium sized businesses is done by five banks. That's worse than China, India and if you go to the US there are thousands of regional banks. This is a very, very concentrated market and there are loads of hidden fees and commissions," he explained at the event organised by digital creative agency Albion London.

"We thought, you've got a huge swathe of people getting low returns on their money, completely dissatisfied with the banking system, is there a way to bring these two dissatisfied parties together?"

Change of Attitude

Goodman pointed to the banking crisis and the issues of trust that it raised in mainstream consumers as the catalyst for a whole number of new enterprises.

Suddenly big businesses - especially financial institutions deemed 'too big to fail' - were not seen as the safe bet they had always been.

"There's lots of in-depth analysis about the cause of the banking crisis and the cultures and the behaviours that underpinned it but I think it translates for most mainstream consumers into a bad smell," Goodman said.

"In the past where big was a signal of trust and authority, in all kinds of business, especially financial services, that is now slightly broken and people are open to getting their financial services from different kinds of companies."

Goodman also pointed to a generational shift in attitudes and behaviours as 'Generation Z' starts to enter the financial marketplace.

"They've never seen banks working as they were supposed to. All they know is banking and financial services being broken and under the cosh, so they are really open to doing things a different way. They look at the whole market with fresh eyes," he said.

Desai claimed the shift in habits meant even mainstream consumers were willing to try out new services to see how they worked.

He revealed that modern day individuals found it easier to invest their money on sites such as FundingCircle.com than businesses did.

"The trust issue is actual more of an issue for businesses than it is for individuals. Individuals will quite happily sign up, start lending money and try it out. Whereas for businesses lending money is a very emotional thing and they have to be very reassured," Desai said.

Change of Regulations

Klein, who was introduced as the 'godfather of VC in Europe' after investing in ecommerce businesses back in the '90s, suggested that a new breed of internet businesses needed a new set of rules.

He felt that regulations set up to control traditional banking systems were out of date when it came to the services offered by internet start-ups.

"There's no question it needs to change. Regulation is not designed for the current products," said Klein, who is now one of the principal VCs behind seed funding at Index Ventures.

"One that is close to our heart is the regulation that requires APR to be calculated on a loan whereas it is completely irrelevant. It is frustrating because regulation changes very, very slowly even though when you speak to regulators privately they admit this is an out of date measure. I just use that as one example."

Wonga.com's Damelin went further and suggested that the reason regulation moves so slowly is that the people behind it are constantly playing catch up.

"Regulators around the world spend most of their time looking in the rear view mirror. And so people are spending time now trying to solve the 2008 problem and we are not even close to figuring out what caused that. Yet that is what they are regulating for," he said.

Instead, Damelin called for solutions that encourage competition in a way that protects consumers and tax payers and makes sure there is safety in the financial system.

"The surest way to do that is to build a principle-based solution that has no carve outs whatsoever. I think that sounds fairly trite but that is not what is being built."

The Wonga.com CEO gave the example that the banks have a completely different regulatory 'carve out' than online companies offering similar services.

"Banks charge overdraught fees, which is what we compete with at Wonga, yet they have negotiated a carve out so that they don't have to show APR. But Wonga and other companies have to show APR that is calculated in very strange ways."

He suggested this led to online companies 'gaming' the system to create products that suit particular loopholes.

The panel debating the topic, What is modern money? And why is it happening?, did not all agree that there should be drop in the amount of regulation.

"We've actually been lobbying for regulation of our industry," revealed FundingCircle.com's Desai. "Peer-to-peer lending is not a regulated activity at all and the business lending market is a completely unregulated market as well."

He said that his company had been lobbying the Coalition Government to create legislation that would set out minimum operating standards. So far he described progress at making the change as "completely unsuccessful".

"We went to see Mark Hoban who is the Treasury minister in charge of regulation, who pretty much said, 'We're not going to do it. We are a deregulating government'," Desai said.

Cutting Out the Middleman

Whether the Coalition increases or decreases regulations, there could be one body that benefits from the web-based financial services emerging online: the Government itself.

FundingCircle.com said that by taking something that was limited to five banks and making it widely available, anyone can now be the banker and lend money directly to small businesses - including the Government.

In the recent budget the UK Government announced that it was considering lending money directly to businesses through platforms like Funding Circle.

"What previously would have happened in a financial crisis is that the Government is left on the side-lines giving money to banks and saying to them please lend more money. Whereas now they can actually bypass the entire infrastructure and actually lend the money directly," Desai said.

"What that should do is attract a lot more institutional money and even businesses can start lending on the platform."

Old Dogs Learning New Tricks

All the positive energy around financial start-ups might suggest the established bricks-and-mortar banks face being left behind.

Albion CEO Jason Goodman pointed to research carried out by his organisation that suggested modern consumers felt banks were totally out of touch with their needs.

"In our research we see that they are really frustrated by banks focused on long term financial products which have no relevance to this audience at all, who never think that they'll be able to buy a house. They are frustrated by the banking system and the lack of real time information and laughably poor online services. They ignore all communications from banks - put them straight in the bin - because they assume banks are trying to sell them something," Goodman said.

The panel at the Albion Society debate suggested it would be foolish to think the major players would not learn from their mistakes and even acquire the start-up companies they needed to offer similar financial services themselves.

"I think that over the next 15 years or so we are going to see a re-emergence of the dinosaurs in financial services - the big brands such as Lloyds, Barclays, HSBC," pondered Klein.

He gave the example of how the big retailers and High Street brands didn't understand and ignored ecommerce when it first emerged and how they had since bounced back to be a force in that market.

"The finance director of Next famously said this was a fad and it was going to disappear and today one can't ignore the role that they are playing in this market, whether it is Argos, Tesco, John Lewis," he said.

He also warned internet start-ups that it was not enough to be first to launch in a new area, even if the company gobbles up huge market share and is well thought of by users.

"They are going to have to keep innovating. We've seen this before," he said. "Let's take First Direct which reimagined banking. Fantastic success, drew a huge number of consumers for whom that brand really spoke but it ran out of steam... or got too large or focused on the wrong things. Innovation stopped. This is the lifecycle of businesses and brands."

Banking Basics

The panel also agreed that while they wanted their online services to flourish, they did not necessarily want to replace the existing banks.

They praised the underlying infrastructure that banks provided, even if they would like to change some elements of it.

"I would prefer a banking infrastructure that looks much more like an energy company. They are essentially utilities and you get your current account, get your basic infrastructure and all the other innovative stuff is side-lined off to companies like Wonga," said Desai.

"You always need the banking infrastructure - it's a fundamental part of the country and the system but I don't think it should be mixed up with all these other types of solutions."

Damelin said he fundamentally agreed with that assessment and confirmed that citizens wanted a stable infrastructure that they can trust and that operates in the customer's interests.

However, he took Desai's idea of banks operating like utility companies and added a twist.

"To be controversial, one idea that hasn't really been discussed that is interesting is to have one Government-owned bank that just does very basic things," Damelin suggested.

"It doesn't try to deliver consumer services that aren't interesting or innovative at all. It holds accounts that people trust and doesn't have a lot of leverage embedded in it and has digital identification that people trust. It holds capital and puts the Bank of England resources behind it. There's no possibility of a run on the bank ever. But it doesn't try and build innovative services because entities like that aren't good at that," he said.

He admitted he thought that was unlikely to be put in place, adding "I don't think that's going to happen."

From Liberator to Dictator

If there is one conclusion to be drawn from a discussion about Modern Money, it is that the exciting new ways to deliver financial services online are as vulnerable of becoming out of touch as the existing banking establishment.

After the rush of success brought by creating a new system or solving a previously overlooked problem, what is to stop a young, fast-moving online company from becoming bogged down with the worries of shareholders or the need to maintain and increase its yearly profits?

In effect, how do you stop yourself becoming the thing that you replace?

"If we want to take the step from interesting products that innovate at the edge of financial services to genuine champions that create disruption and focal points for changing financial services, the companies that are starting up around the grid of financial services need to take that step in terms of how scale," said Damelin.

"That's an interesting world that's untested so far, which is how to do that and not become the traditional bank."

Venture capitalist Klein argued that it was ultimately about ensuring that the culture within these new technology companies remained intact as they get larger and become household names.

He warned start-ups to retain their "focus on the customer, focus on what they need and how their needs are changing and the speed one has to adapt one's product, one's offer, one's communications."

"I do believe these big incumbent brands will reimagine themselves in time and the challenge for us upstarts is to ensure that the principles on which we founded these successes remain right at the heart of what we do in the future," he added.

Must Read:

What Not to Forget When Starting Your Own Business

Exclusive: Wonga.com is Not for Sale Says Co-founder Errol Damelin

Why the 'Second Screen' is Your Next Key Marketing Strategy