How do you know when a cycle of hype is reaching its peak? When the mainstream players try to muscle into the market. It finally filters through to them that there’s something happening out there, and that they’d better jump on board if they want to look cool. It’s a bit like seeing your grandfather get a new motorcycle, complete with leather jacket. Fun, maybe, but not very reassuring, especially when it appears to be hype-motivated.
I’ve been doing some work on the concept of disruption recently, and how often the word is misused and misunderstood. I’ve also been doing some work on the fintech sector (financial services + technology), and it is fun to see my two pet projects come together. At the end of last week the Financial Times had as its main headline “Goldman and SocGen eye peer-to-peer lending push”. The sub-header in the print version read: “Big names move in on tech-led sector intent on disrupting traditional finance.” Ugh, there you go. Disrupting. What’s wrong with the word “innovating”, or even “changing”? Traditional finance may have increased competition, but it isn’t going to go anywhere, so where’s the interruption that disruption implies? I could go on and on about this misuse of jargon, but let’s move on…
A brief look at the alleged disruptors: Peer-to-peer finance is a flourishing and relatively new subsector of the financial field, in which online platforms bring together lenders and borrowers. It’s a great idea, it makes money more efficient and gives ideas life, with increased transparency and accountability.
But, are these platforms “disruptors”? Peer-to-peer finance is not exactly “new”. It has been around ever since someone said to someone else “Can you lend me a fiver?” And lending outside of the traditional banking system? Not new, either. It’s even mentioned in the Bible, and I believe that Shakespeare wrote quite a good play about a lender who operated outside the official system. What is new is the efficiency that the new communication technologies make possible.
With online platforms, everyone can become a lender without needing “enforcers” with large biceps. You open an account, you deposit your money, the platform distributes it for you, and you earn a higher rate of return than you would in a standard savings account. And everyone has access to a loan, assuming their credit risk is good. You apply, submit to a credit check, commit to the monthly payments, and receive the funds. It’s popular: the sector grew by 200% in 2014, y P2P lending in the UK market is expected to exceed £2.5bn. And it is a force for economic good: money works harder, generating more wealth for all.
The key innovation here is transparency, which fosters trust, which in turn keeps costs down and returns high. Doing a credit check is becoming easier, with so much personal information online. Lenders feel comfortable committing their funds, especially if the platform has provisions for default. They get a higher-than-standard return, without losing access to their funds. And they like knowing that they are contributing to the “real” economy. With a bank, you deposit your money, and then you have no idea what the bank does with it. Maybe the bank will lend it (more unlikely than a few years ago, let’s face it), or maybe it will put it into a hedge fund. Part of your money, certainly, will go to finance the bank’s considerable overheads. With these platforms you know that your money is being lent to individuals who need to finance a degree, a house extension or the purchase of a car, or to businesses who will use it to expand operations, renew equipment or finance working capital. Some platforms even let you choose the project you will lend to.
So in what way are the mainstream players muscling in? Isn’t peer-to-peer lending outright competition?
In January of this year RBS announced that it was partnering with Funding Circle and Assetz Capital, in that it would recommend these platforms to the commercial borrowers that it rejected. Is anyone else noticing the irony here? “So, you’re not good enough for us, we don’t think that you’re a good investment, but try these people.” And this is being spun as an innovative move by RBS and a good deal for the P2P platforms. Take away the spin, and RBS is left with a fairly public announcement that they are not excited about lending to businesses, and the platforms are left with a fairly public willingness to accept borrowers that others have deemed bad risk. Santander reached a similar agreement in June of last year.
The FT article referred to the possible investment of Goldman Sachs and Société Générale in Aztec Money, a platform that allows commercial finance companies to “buy” corporate invoices. If a company makes a sale that is payable, say, in three months, it can sell that invoice to another buyer. The company gets cash right away, it doesn’t have to wait three months, but in exchange, it accepts a lower amount. The buyer gets a good return on the investment, ie. the difference between what he paid for the invoice and what he will get paid by the company’s client when the invoice becomes due.
This also has worrying connotations. If the big boys are interested because they recognize innovative competition when they see it and figure that it’s better to join forces than to obliterate, then the development is encouraging and exciting. This will bring real innovation to the traditional finance sector. If, however, the mainstream houses want to repackage the consumer loans or, in this case, the corporate invoices into new instruments which can then be repackaged into newer instruments, we will just end up extending the risk on tenuous bases, which should sound familiar to everyone, and could well end up getting the whole economy into serious trouble again.
And, has anyone bothered to ask in what way is this “peer-to-peer”? With Aztec Money, the “disruptor” (cough) of the article, the ones that give the money are commercial finance companies. The ones that take it are businesses that sell physical products, in this case, mainly agriculture-related. They are not peers. Along the same lines, in what way is this “lending”? The cash exchanges hands because of the sale of a document. Not exactly a loan. Really, let’s focus here.
Moving onto the sub-heading of the article which alleges that the new platforms are intent on disruption, I seriously doubt that the founders and CEOs want to bring down (= “disrupt”) the traditional financial sector. That would not exactly help the world economy. What they want, and reasonably so, is to set up alternative forms of financing, to satisfy needs that the ultra-conservative traditional banks can’t, to take over from them the role of kick-starting the economy. They probably also want to revolutionize the way we do business, and while they’re at it, change the world. But bring down a vast and somewhat crucial sector that deals in so many areas that the new companies don’t? I don’t think so.
Now, I am in no way anti-innovation or anti-deals. I am anti-hype, and praising the traditional banks for joining forces with the new players is premature. These are exciting times for the financial sector. The innovators are playing an increasingly important role in the efficiency of the economy. Money works harder with them in the market, and everyone benefits: the funders, who get a higher return on their money, which they can then reinvest; the fundees, who can start projects, launch ideas and eventually make profits which they can then reinvest; the platforms, who are making a well-deserved commission on the funds they channel; and the traditional banks, because a good chunk of all this extra money will end up flowing through their hands at some point in the supply chain. A net win for everyone. But let’s try and keep the hype out of it.
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For more on fintech (financial services + technology), take a look at my Flipboard magazine: