By Yvan De Munck on 22nd April 2014
(This is an excerpt from the full paper published originally in the Capco Journal of Financial Transformation #39 @ http://p2plend.it/QgehZ1)
The Great Recession, increased regulation, regulatory backlash, and the decrease in consumer confidence in the banks have led to major disruptive developments in the way people and small businesses access credit, an important element to the growth of the U.S. economy. Given that more than 70% of U.S. GDP is related to consumption, access to credit is required for continued growth. As a result of the aforementioned events over the past five years, peer-to-peer and online direct lending have rapidly emerged as a solid alternative to mainstream banking and lending. It is poised for very strong growth and is likely to change the landscape fundamentally in a relatively short time.
The banking sector continues to be one of the few remaining sectors where fundamental disruption can still occur as banks find themselves in a unique environment where government related institutions implement new changes, leaving banks paralyzed and unsure how to move forward. As these recent competitive forces are unlikely to reverse (barring any legislative action) the banks and other intermediaries really only have three options: join them, innovate, or die. Given that the latter is not an option (though the banking sector has gone through a phase of massive consolidation since the early eighties with less than half the number of banks left), banks and credit card companies are having difficulty determining how they will be able to beat the continuing onslaught. Joining the party and splitting the spoils to the benefit of all involved is the preferred, if not the only, realistic option for most. The concept of “collaborative consumption” is increasingly pervasive in our culture and peer-to-peer and online direct lending, it can be argued, is an expression of this new movement in which trust is the “new currency.” To win that “currency” back, traditional financial services companies will have to think outside the box, to regain their place at the top. The issue is timely, urgent, and not going away any time soon.
“First, small businesses have insufficient access to credit, and that situation is worsening. Second, their credit performance as a group suggests that they should be getting more credit” (Renaud Laplanche)
“Bank 3.0 – Why Banking is no longer somewhere you go, but something you do” (Brett King)
As markets are hitting new highs, the Federal Reserve is reluctant to aggressively taper its stimulus package and the economic outlook is murky at best. The Fed must continue to accommodate multiple constituencies, even under new leadership. While the Fed continues to see its actions as “data-dependent,” risks are ever increasing: inflating financial assets, nervous market participants who could respond aggressively upon any hint of further tapering, low long rates that could be at a turning point, and subpar economic growth rates and unemployment levels close to five years after the official end of the recession. All the while, both the banking sector and the U.S. Congress are vying for last place in terms of popularity.
At the same time, we continue to see that both consumers and small businesses have increasing difficulty accessing credit, which seems to be one of the reasons this economy is nowhere near its ideal growth rate. This is especially odd given that the main banks in the U.S. are once again bigger and more flush than ever. So what is happening and why?
“The funds U.S. banks had available for lending to businesses and households increased last month (October 2013) by $95.8 billion to an all-time record high of $2.3 trillion. What are the banks doing with that enormous liquidity? The answer is: nothing. Banks simply put that money back where it came from: at the Federal Reserve (Fed). They chose the Fed deposits paying 0.25 percent, instead of earning 4.5 percent on new car loans, or 10 percent on two-year personal loans.”
Weak bank lending continues to be one of the main culprits for the current situation, with loan growth rates far below where they should be at this point in the cycle. At the same time however, non-bank lending is growing at close to 10% per year, driven by alternative finance companies, credit unions, and, increasingly, peer-to-peer (P2P) and other online direct lenders. This is where it gets interesting. This is where we need to pay attention.
“What we have here is a case where the transmission channel between the monetary policy and the real economy is clogged up. Instead of financing aggregate demand, the liquidity created by the Fed is being deposited by the banks back at the Fed at an interest rate of 0.25%. With every loan banks write, they are taking an investment decision whose expected income stream should be profitable. The fact that banks now apparently consider that their risk-adjusted return on consumer loans are lower than the 0.25% deposit rate at the Fed is a serious indictment of the monetary and fiscal policies they have to contend with.”
So if banks are not going to change tack any time soon, how can we find another way to increase loan volume? Welcome to the new world of peer to peer and online direct lending.