Month: July 2012
Originally published in The Huffington Post, 15 July 2012.
The Bank of England and HM Treasury officially launched the “Funding for Lending Scheme” (FLS) on Friday 13 July (read the announcement and details here), yet another covert operation to shore up the banks under the disguise of helping small businesses and households to access cheaper credit and thus stimulate the economy.
Sure, some of the money will find its way to you, me and our businesses. However, I guarantee that the vast majority of the funds the banks draw down from the scheme (with obvious glee) will not make its way to those who need it most. The reason is quite simple; lending to SMEs and households carries a high cost for the banks in terms of capital requirement and consequently has the lowest rate of return of any of a bank’s activities.
We look to the government and their related bodies to effectively set tactical and strategic policies that instill the right incentives within the private sector to do what is best for the UK economy. Is the government providing the right incentives to the banking sector to open up lending to SMEs and households? No – and they know it. Banks will have a channel to access cheap capital; how they use that capital is not, and will not be dictated to meet the specific need of SMEs and consumers.
The level of low cost capital available to the banks under the FLS is a factor of the credit they already extend to non-financial entities in the UK plus any new loans made to this segment. Without lending a new penny, the banks are eligible to access £80 billion of cheap capital from the Bank of England. To access more, they can simply lend to their core customers within the large corporate space, those with strong credit rating that also feed the most risky activities of the bank’s capital markets division through their requirements for complex derivative products.
A loan portfolio consisting of SME loans is considerably more expensive for a bank to hold then a loan portfolio consisting of large corporate and (financial) institution loans. A scaling factor of 40% (of the loan) or less is used when calculating the capital a bank must hold to cover potential loss on a large corporate or financial institution loan, compared to a 100% scaling factor for SME and consumer loans.
Looking at loan revenues: on average, a bank may earn 8% on SME loans and 5% on large corporate loans. This 3 percent benefit in no way compensates the difference in the capital requirement (cost) between SME and large corporate loan portfolios when calculating the return on capital, a core metric for effectively allocating money across projects/business units.
For a complete picture, lets also note the off balance sheet activities of banks – the complex derivatives they trade in the capital markets division that can reap them considerable revenues but cost the bank nothing in terms of regulatory capital.
Banks are privately held entities. They do what is best to maximize return for their shareholders. If a bank has one hundred (100) units of capital at its disposal, it will, like any other private firm, look to allocate that one hundred in the most effective way to generate the maximum level of return on capital.
So, if you ran a bank and have one hundred units of capital available, what would you do it with it?
Given the incentive structure, in this case, the capital requirements dictated by regulatory bodies such as the FSA, Bank of England, the EC and the Basel Capital Accord, you would logically do as the banks do, allocate as little of that capital to lending to SMEs in order to maximize shareholder return. This is why Project Merlin, the effort by the Government to tie banks to lending targets, failed – though a token effort was made due to brand necessity, the proportion of loans made to SMEs relative to large corporates fell considerably and continues to fall. This is also why the FLS will fail to meet stated objectives – the incentives are simply not there for banks to lend to SMEs. Given the current trajectory of regulation, I would even stick my neck out and state that banks will look to exit the business of lending to and generally providing SME services within the next 10 years.
So what? Let them. We can do better. The alternatives are already here and innovation in the New Finance sector is progressing at a lightening pace. Entirely new banking models such as Fidor Bank in Germany, Holvi in Finland and Simple and Movenbank in the US will soon migrate to the UK. There are already several young firms focusing on niche elements of financial services to deliver exceptional, transparent and cheaper services to SMEs and consumers. There are firms providing Peer to Peer based access to credit, such as Fundingcircle, Zopa and Fundingknight, other firms providing lower cost access to currency and international trade services, such as Tradeshift, Currencyfair, Transferwise and Azimo.
The Government will continue to support the banks albeit stealthily; avoiding association to bypass the negativity of the media and population directed at the banking sector. Financial services is the comparative advantage of the UK, the thing we excel at and the rest of the world wants from us. UK financial services drives wealth creation for us all, and the government knows this. We should therefore stop waiting for policy led solutions to the system – they are not coming. We should take it upon ourselves to instigate the change we need.
Originally published in The Huffington Post, 05 July 2012.
No more excuses; this is a broken record. Credit crisis, moral hazard, payment protection insurance, taxpayer bailouts, mis-selling, bumper bonuses, rogue trading, “Muppets”, collusion, lending…..the scandals hitting the banking industry roll on and on. The time is now to shift the balance of power away from the banks, to make them sit up and listen. It is time for customers to take control and vote with their feet for better and cheaper services and for transparency and fairness.
Fixing LIBOR and EURIBOR. Mis-selling interest rate products to SMEs. “You have been a naughty boys,”say the FSA, a slap on the wrist for Bob Diamond and some fines. We, consumers and SMEs, will ultimately bear the cost for the penalties handed down, not the bank’s big business or institutional customers. We let the banks get away with it. We continue to fill their coffers.
We can’t rely on policy makers or regulators to improve the banking industry. They are applying sticky tape to the gaping fractures that have been exposed and I guarantee the tape will eventually be stretched and ripped apart exposing again the hazard beneath.
If we were to design the financial services industry today, anew, what would it look like? An industry based on the world today, on a fresh understanding of incentives and needs, on technology and new business models, is what I see as the true solution to the crumbling system that surrounds us. A solution that we, as consumers of financial services, are capable of making a reality through our actions and choices.
The banks see us as the least price sensitive segment – we are their goldmine. The big 4 banks in the UK control 85% of SME banking services and about the same percentage of consumer financial services. This oligopoly has hardly been dented since 2007, even though the number of viable alternatives has risen sharply. Entrepreneurs have been drawn to solve the obvious issues and to deliver better services. The next generation of firms are spawning, focusing on specific niches within the chain of financial services.
We are unfairly taxed by the banks for our loyalty. The price discrimination applied to small business and individual customers is staggering and totally unjustified in an age of digital processing. We need the banks to hold and look after our money but we shouldn’t then be handing them disproportionate levels of our hard earned income for a range of bolt-on financial services, especially given the inferior quality of the service we receive.
It is unquestionably cheaper to access the services we need through independent next generation providers. It will get even easier too, as “New Finance” firms come together to form complementary ecosystems that deliver services through a single customer interface. These firms look to analogous financial technology businesses to supply the building blocks for their solutions. New Finance firms recognise, as we all should, that the real competencies of banks are in deposit management, back-office operations and capital markets liquidity – the rest is better done elsewhere.
Firms such as Funding Circle, the peer to business lender, Money Dashboard, Zopa, Tradeshift and Fidor Bank are working hard to be excellent at fulfilling customer needs, delivering business model innovation to lower cost with high quality technology based services that provide a more fulfilling customer experience, all wrapped in the required layers of security.
It is too late and too expensive for banks to bridge the massive gap between customer needs and the services they deliver. When the banks should have been taking risks with their adoption and use of technology, they took risks with our money instead. It is time we punished them for being below par; we wouldn’t use a cowboy builder twice, so why do we stick to our cowboy banks? We must help the next generation of financial services firms succeed. The power is in our hands; we must embrace New Finance for our own benefit. Shrug off the apathy – take action.
The tipping point has been reached – banker bashing has gone too far. The hysteria and portrayal of the “despicable” individuals that work in financial services is yet another story that the media has spun beyond the realms of reality and reason.
Sure, there are unscrupulous and venal individuals in the industry, but no more than in any other. Labeling all bankers as evil incarnate, motivated by greed, is ridiculous. The “99%” are ordinary hard working people that live down your street, that take days off to attend their kid’s sports day, that would rather be at home with their family then jumping on a private jet for a hedonistic all-nighter in Monte Carlo.
I have never met anyone in the industry like those that have been described in the press of late. The attacks on the culture and, more worryingly, individuals and groups, is creating a sideshow that is stealing the focus away from the real issue – how to change financial services for the benefit of the customer and the UK economy.
It is not the fault of individuals that financial services is failing. The industry is not structured in a way that suits today’s business and consumer needs. We should not be focused on demonising people who are typically as honest as the rest of us. We should instead be looking at the wholesale change to banking structure, and business models therein, that is needed to improve customer service, transparency, trust and to lower costs.
A movement is already under way. We are living in an age where change in the management and delivery of financial services is occurring at lightening speed. However, it is not the legacy banks that are at the forefront of this evolution, nor the policy makers and regulators that are simply applying cheap sticky tape to gaping fractures. It is “New Finance” that is gaining momentum; entrepreneurs and small businesses that are leveraging technology to address the fallacies of the system and to improve the industry for you, I and our businesses.
Perhaps the current hysteria will finally be the catalyst to encourage customers to vote with their feet, as that is ultimately what is needed to make change happen. It is astounding that 85% of business banking and a similar proportion of consumer/retail banking is still conducted with the 4 major UK banks. In a recent survey conducted by the Payments Council, 2 out of 3 people in the UK said they were still loyal to their bank despite the brand and trust destruction the industry has suffered over the past few years. Over the five years to 2010, 80,000 customers switched their banking provider – that’s less than 1/8th of a percent of the 64 million+ accounts held in the UK.
Competition, innovation and a re-focus on the customer is the key to improving the practices in financial services and to deliver better services, fairer services, for consumers of financial products. Rather than holding all bankers to account, lets drop the hype and focus on the real and practical change that can cement an era of New Finance. The power is in the hands of the customer – you must embrace the new, alternative, cheaper, more transparent providers of financial services and thus feed the seeds of a better system.