Elon Musk once commented that “money is low bandwidth” – it’s highly susceptible to being overhauled by the internet. I was reminded of Musk’s observation by Cormac Leech, director of fintech at Liberum. It’s easy to get those inside the alternative lending industry to talk about how it’ll “change banking forever”. But what does someone within an alt fi-friendly investment bank think?
You’ve warned about the threat alternative finance poses to banks. How should banks be responding?
Banks have a problem. Essentially, they’ve been over-charging customers for decades. They’ve been enjoying super-normal revenues because they’ve had a government-subsidised oligopoly, admittedly largely offset by high costs due to outdated infrastructure. Their challenge is that, via technology, there’s an alternative way to intermediate between savers and borrowers that’s more than twice as efficient.
To minimise future market share loss, banks have to do, to some extent, what General Electric’s Jack Welch used to talk about – destroy their own businesses. That’s counterintuitive because, in the short term, it implies self-inflicted revenue loss.
The issue with the alternative lending industry is that it’s still small – only 1 or 2 per cent of the total lending market. But in the long run, it’d be the smart thing for banks to do.
It is a real dilemma, compounded by the fact that most chief executives of large banks are only in their jobs for perhaps three to five years, and therefore have a short-term horizon. And this industry won’t impact banks materially for five to 10 years – but it will ultimately reduce banks’ consumer revenues by over 40 per cent on some estimates.
The only conceivable way that banks will become motivated to react in the short term will be if equity investors start to derate bank share prices in anticipation of the existential threat they face a decade from now. And the issue with that is that equity investors are typically myopic. Most invested in banks are looking one or two years ahead at best. Tell them fintech is a long-term threat, and they don’t believe it.
In short, the options banks have are: to develop their own platforms separate to existing operations; or acquire existing platforms. They should also consider improving their user experience, including by broadening their product offering.
There’s no reason banks can’t move into retail, the travel industry – even dating agencies! That way, they’ll take the fight to the tech companies, rather than continually being on the back foot.
They potentially have a very deep understanding of customers’ buying preferences, so they have a strong opportunity to create customer value beyond banking. But there’s no indication any of them are going to do that.
What about how the alt finance industry will develop into areas of banking?
Up until now, everybody in this industry has always looked to lend on a perfectly matched basis, so you can never have a liquidity crisis. Banks are doing maturity transformation and the general wisdom is that P2P platforms can’t do this, because they always have to be connecting a lender and a borrower. But if you think about what this industry will look like in 10 years, in my view, it’ll generally be extremely liquid.
It’s not unreasonable to expect that, within 10 years, we’ll see £60-70bn of P2P loans getting repaid every year in the UK, with all that capital looking to be reinvested: that implies a very significant amount of liquidity. If a lender needs to monetise their loans quickly, they will likely be able to sell immediately at a small discount on a secondary market.
And that means being able to treat your P2P portfolio as something very close to cash. Think about what cash is. It’s an interest-free loan that everybody is making to the government. So why, instead of having £10 in my pocket, can’t I have £10 of loans that I’ve made to other people?
Rather than having a promise that the government’s going to pay £10 to the bearer, have a promise that those being lent to are going to pay £10. The difference is that, when you have the latter in your pocket, you’re earning interest on it. Think about the amount of cash people have sitting in current accounts not earning anything.
We think there’s enough interest in the sector now that institutional liquidity lines will be provided to P2P platforms that want to go in this direction. And ultimately, as the sector gets bigger, I think the Bank of England will be willing to act as the buyer of last resort, of performing P2P loans in the secondary market at a discount.
Governments have a strong incentive to make this industry thrive, because it’s so good for the economy in terms of boosting productivity and reducing the systemic risk inherent in banks. It may still be 10 years or more away, but it’ll happen – at which point P2P lending may start to more comprehensively displace banks.