Banking. It will never be the same again.
There is nothing new about one person lending money to another. What is new, however, is that companies that enable this simple human activity to take place on a massive scale are now emerging. They offer consumers and small companies a genuine alternative to going to the banks for savings and loans. It's called peer to peer consumer finance (P2P) and in fact it's a better alternative
There is nothing new about one person lending money to another. What is new, however, is that companies that enable this simple human activity to take place on a massive scale are now emerging. They offer consumers and small companies a genuine alternative to going to the banks for savings and loans. It's called peer to peer consumer finance (P2P) and in fact it's a better alternative.
Savers get to choose the rate they are happy with and can even choose whom they want to lend to. Borrowers get the finance they need with investors competing to give them the best rates.
The companies providing the technical capability behind P2P call it a 'platform' or 'digital marketplace' that simply provides a service and makes a fair margin. Profits are directly linked to the success of the marketplace, and that means they are fully aligned with investors and borrowers.
The market place is efficient, transparent and open to all, whereas in the current consumer credit environment such qualities are in at a premium. Add to this that the markets are fair to all involved, and it's easy to understand how technology enabled P2P lending is an important part of today and tomorrow's consumer finance ecosystem.
There is a 'but', however, and it's quite a big one. Typically, disruptive technologies transform markets. Legacy businesses and technologies either adapt or die. When technology is involved this can happen very quickly indeed. Yet despite P2P lending firms being open for business for seven or eight years their impact on the market has been negligible.
Zopa, the UK market leader, has loaned out around £250m over seven years, and Funding Circle (targeted at small businesses) around £60m in two years. This is a drop in the nearly trillion pound UK retail finance ocean.
A possible reason for this alternative banking model not being taken up more widely is that it hasn't get grabbed enough market share to motivate the banks to change. However, I suggest that the main reason is down to entrenched consumer habits; or laziness on the part of consumers. The banks barely notice £60m missing from the market and won't respond until they feel that their monopoly is genuinely under threat. But the customer has no such excuse.
My hunch is that customers don't really appreciate the alternatives available to them. They can't possibly be happy with a 1% rate of interest (unless they are lucky enough to live in Switzerland), but are either too lazy to transfer their money out of the banks and put it with the likes of Zopa. Or perhaps they are too lazy to find Zopa in the first place.
The only other possible reason for this illogical behaviour is that customers don't trust the new companies to keep hold of their money. Given the performance of the UK banking sector over the last few years, however, this kind of theory seems a little too surreal to take seriously.
The UK Government has recognised this gap in the market and the opportunity it presents. Today it announced that it will make £60m available directly to P2P marketplaces such as Zopa and Funding Circle.
The reason for this is twofold. The headline rationale is that providing cheap money to the banks in the hope that they will pass the money on to the real economy simply isn't working. The bank balance sheets are so sclerotic that the money seems to disappear. If the government's approach works, expect to see more of it. Eventually the banks will take notice and may even act!
The second reason is that customers are entrenched in their habits and have perhaps lost trust with any kind of financial institution. They clearly don't trust banks but should they trust a start up with a somewhat abstract concept?
So what does this mean for consultants advising their financial services clients?
From a business perspective we should be suggesting that our clients take a very close look at the business models used in P2P market places and see if they can't provide a similar service to their existing customers. Virgin explored this idea back in 2010.
What if Bank ABC took a white label version of Zopa and used it as an internal market for its existing customer base? Could it be a possibility that high net worth customers would be provided with access to the market place and would provide liquidity? Might other customers simply choose between rates offered by the bank and its traditional lending model and those on offer through the marketplace? The new entity would have to compete for customers and capital with its parent bank, but with brand, trust and customer preferences neutralised it would provide a level playing field for the P2P concept.
From a technical perspective there are two key themes. The first is around the customer experience provided by the start-ups. They are working with new technology and don't have the legacy issues that banks have. Nonetheless, they have implemented plenty of good ideas that could be adopted by retail.
Why not provide investors with a statement of who used their money and what for? Publish defaulting account information to retail banking depositors. Demonstrate how this can adversely affect repayment. It would be a harsh lesson for savers perhaps, but true to life and demonstrably transparent. As they won't actually lose their savings it might even help them appreciate what the banks do for them.
Secondly, shouldn't investors have greater control over their investments? Shouldn't they be able to choose their risk appetite more actively? Why shouldn't they be able to increase their risk profile for a particular period of time? Why shouldn't they be able to support particular markets?
Finally, I could have penned this blog a few years ago with more of less the same message, so what is different today? Well I think we've reached the tipping point. The technology is proven, the alternatives of staying with traditional retail banking couldn't be worse, and now that the government has formally endorsed the concept it is surely a matter of time before the early adopters are joined by fast followers and eventually the masses.