Investor protection vs Access to Finance: The Growth of Alternative Finance

The presentation embedded below is an interesting perspective on the growth of alternative finance, specifically in Europe. There has been a certain amount of discussion regarding the tepid growth of investment crowdfunding in the US (not including marketplace lending) and the reasons why the sector has not grown quicker.

To foster an ecosystem of robust options of alternative finance, such as P2P/online lending and equity crowdfunding, it is vital that there is not only demand for access to finance but that the regulators are open to change. As all forms of financial services permanently move to become internet based, regulators and policy makers are dealing with a shifting environment. Many rules that govern finance were written before social media and instant global communications became a normal thing.  Regulations and policy makers that are too cautious and strict may stifle innovations in finance. Little to no regulation allows alternative finance to grow rapidly but, perhaps as one may expect, to the detriment of investor protection.

Ronald Kleverlaan, Director of the European Centre of Alternative Finance Utrecht University in the Netherlands, has produced a presentation that shows sector growth of Fintech.  The Alternative Finance Maturity Model visually displays the various stages of introduction with the final stepping being maturity where alternative becomes the norm. Clearly in Europe (Brexit aside) the UK has led sector growth. A combination of a culture of entrepreneurship and risk taking has combined with a supportive government and a regulatory body tasked with a mission of fostering competition – perhaps to the frustration of traditional financial firms. The rise of internet finance in the UK has engendered few occurrences of fraud to date. Growth has been sustained. Perhaps the Brits have gotten the balance right so far?

But which country has the largest alternative finance market in the world? China, of course. The world’s second largest economy has benefited from several variables.

First, there was a need to provide access to capital for smaller firms across a large country that larger banks were ill prepared to facilitate. Secondly, the rapid rise of ubiquitous smartphones meant brick and mortar operations were not necessarily needed to provide sophisticated financial services. And finally, the government waited and watched before enacting any updated rules. Thousands of platforms launched to provide internet finance services. The peer to peer lending market in China dwarfs the rest of the world, including the US (marketplace lending).

Of course, China’s rapid growth brought cases of profound fraud and limited investor protection. Updated regulations are taking hold now as winners emerge and the government feels it is time to provide guidance on operational requirements. Consumers are becoming more comfortable with investing and borrowing mostly online. The wait and see approach comes with a good amount of risk perhaps best exemplified with the Ezubao fraud – one of the largest ever.

Lessons learned?

Kleverlaan points to Italy as a country that has stumbled out of the gate. Something the country is attempting to rectify with recent rule changes specifically targeting equity crowdfunding. But any policy maker interested promoting an innovation based economy and who is supportive of small business should seek to study the experiences of  other countries. There are some prominent regulators that appear reticent to benefit from the knowledge of others.

A well defined regulatory structure is crucial for sustained sector growth. But regulators that are entrenched in the mantra that investor protection trumps all may short consumers and businesses in the long run. A more balanced approach that encourages innovation while allowing some risk is more beneficial to all.

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