By Nils Thygesen on Tuesday 5 August 2014
Continental Europe has a strong tradition for financing through the banking system. In Denmark, the well-functioning mortgage institutions have a majority share when it comes to financing of both corporate and household buildings. The Danish mortgage institutions represent a history of more than 200 years, ever since a big fire in Copenhagen in 1795 initiated the concept. The flames eroded almost 25% of the capital and the challenges of rebuilding the city were remarkable. Originally, mortgage loans were typically 20 and 30 year fixed rate loans, but within the last 20 years financial innovation has secured development of floating rate notes and loans without instalments. Therefore, mortgage financing is actually a kind of alternative financing representing a strong history without loan loss disruptions. In recent years, increased lending from the Danish mortgage institutions has compensated squeezed bank balance sheets, as tougher capital requirements make bank lending more cost
Traditions are seldom easy to change. That is probably one of the most important reasons why alternative finance is not especially broad based in Scandinavia. A relatively high bank intensity (many banks per inhabitant) and high loyalty between banker and client make it difficult for independent players to get a foothold. Lending from non-banks feels uncomfortable for many private individuals and lots of corporates are not big enough to tap the bond market, where liquidity is scarce. Recently, entities collecting pension funds for financing SMEs have been established. However, until now it has been no outspoken success. In our opinion, one reason could be that pension organizations prefer a more broad based exposure to credits than direct lending as the latter demands relatively heavy resources to assess credit quality and follow up activities. We see a better perspective in financing the SMEs through crowdfunding, where small and midsized lenders are also able to buy shares of loans.
Three factors points to an overall change in the dearth of alternative finance in Scandinavia. Firstly, there should be demand for direct lending return in a scenario where both stocks and bonds are heading full valuation. Secondly, currently European banks are selling off large chunks of their loan portfolios or simply deleveraging to accommodate to the Basel III capital requirements, creating a supply of loans for alternative finance providers. Thirdly, political sentiment is working in favor of a more friendly regulatory environment for alternative finance providers, leading to several relaxations that eases doing business. On the borrower side, we see possibilities in the crowdfunding of companies, which in banking terminology belong to the “wrong” sector or geographic area. However, capitalization among Danish SMEs is not especially strong, which makes it difficult for them to borrow. We estimate the potential Danish market for crowdfunding to be around DKK 4-5bn.
The Anglo-Saxon countries have a stronger tradition for financial innovation than Europe. Political understanding of the importance of a well-functioning financial sector is far more outspoken than in many Continental European countries where public opinion and a kind of revenge attitude towards the banking sector in the wake of the financial crisis play a role. The U.K. authorities stress understanding of the importance of a strong and innovative financial sector after the recent decision to make it easier to get a banking license and prioritizing effectiveness in the approval process when new players are knocking on the FCA door. That decision demands competences, e.g. the ability to attract and keep the best people in the FCA organization. A future systemic crisis is the main risk in financial innovation. However, if financial regulation becomes too uniform, you probably ignore the danger signs of the next financial crisis.
Chief Risk Officer & Partner