I’ve been meaning to write an article on this for some time. But whenever I start it, I tend to get distracted.
Today, for example, I was riled by Magnus Heystek and his ridiculous article on Moneyweb: Retirement Advice Should Come With An Age Restriction. His main point: “don’t take retirement planning advice from anyone under the age of 60.” Because the younger ones lack life experience, or something. It’s amazing how casually he lets that slide off the screen. It’s as bigoted as saying “don’t take retirement planning advice from women because they don’t make the decisions” or “don’t take retirement planning advice from black people because they can never afford to retire”. Ageism, sexism, racism – all signs of someone whose advice you shouldn’t be taking. And the point doesn’t even have to be moral. Do you only get cancer treatment from a doctor that’s survived cancer?
But I’m getting distracted. Back to social lending…
The Trouble With Banks
Banks are covered with regulation, and weighed down by their size. But before I get there, some background. Any retail bank had two original functions:
- Accepting deposits of cash; and
- Lending that cash out to borrowers (offering credit).
But rapidly, that credit function begins to splinter off into particular areas of speciality:
- Consumer Credit
- Corporate Credit
- Consumer Credit
- Short-term Credit (Credit Cards and Overdrafts)
- Medium-term Credit (Vehicle Financing)
- Long-term Credit (Mortgages)
- Corporate Credit
- Trade Credit (Overdrafts, Revolving Lines of Credit)
- Project Financing (Leasing, Commercial Mortgages)
At which point, governments and central banks start to get confused by what the bank was doing, and where there was risk for the depositors. So they start insisting on Risk Management Departments and Compliance. This required reform of the Treasury and IT Departments in order to produce the information that is needed to keep track of what is going on and where. The number of people involved in these tasks resulted in HR Departments; and the sheer volume of space required to maintain all of these employees demanded cleaning staff and maintenance crews. Then you get Administrators and Client-Relations Personnel and Marketing departments and Expansion Committees and Internal Audit teams. And that’s only the retail arm.
So before anyone had a moment to step back for breath, the banks were megalithic. And megaliths have to pay for themselves through fees and charges and interest differentials.
But perhaps we should take that moment and step back. Because in the end, all that a retail bank should be doing is putting spare money to use. It takes money from people that don’t need it (depositors), and gives it to the people that do (borrowers). It charges the borrowers for using the money, and then passes that fee along to the depositors/lenders, net of a little margin for their trouble. The model seems simple, but there are two main problems:
- Timing (most depositors want to be able to draw their money whenever they feel like it – whereas most borrowers want to borrow for set durations of time); and
- Defaulting borrowers (how do you know if a borrower is good for it?).
So banks have grown large by having to manage the liquidity gap caused by the different time requirements, and by building up large departments devoted to credit checks and dealing with distressed borrowers in those situations where the credit checks fail.
The thing is…
Today’s world is a little different to the one in which banks first came into being.
On the timing front, people are adult enough to decide what money they need to have access to, and what money they don’t. We do it all the time – putting aside money for savings, investments and so on. It’s the reason the banks offer fixed deposits, after all.
And as for the default side of things, the credit information is all out there and easily accessible. There are credit bureaus and so on that track an individual’s credit history – and that history is a collation of mortgage repayments, bank debt and store credit. And there is also social media and the power of public review. Public reviews that people actually use.
So in some ways, at least part of the original process no longer requires a bank as a go-between. We could just sort through the potential borrowers ourselves.
And if you think about it, we’re already in the practice of “offering credit” to people that we don’t know. When we buy goods on ebay, isn’t the first place you look the seller’s rating? In that scenario, you’ve paid before you receive the good, making that in-between period an extension of credit to the seller.
So it shouldn’t come as a surprise that peer-to-peer (p2p) lending is on the rise. From the depositor’s perspective, you get paid a higher return than you would earn at a bank. And for many borrowers, they end up paying less than they would on credit-card debt and pay-day loans.
How P2P Lending Works
[to be continued]