Five reasons why P2P lending can (and will) challenge the banks
Is peer to peer lending "too small a niche" to challenge the banks? That's what P2P licence applicant John Walley argues in an interesting article in stuff.co.nz this morning. It's a stance that we fundamentally, and enthusiastically disagree with. We believe peer to peer lending is in a powerful position to challenge the banks. Here's why:
Peer to peer lending marketplaces don’t use leverage; all loans are funded at a 1:1 ratio. One of the biggest risks inherent in banks and finance companies is that they leverage their balance sheets. This means that they borrow investor funds to add to their existing equity, increasing the funds they're able to lend. Theoretically, it can work - but in practice, it creates significant risk. It's often referred to as the Titanic factor; even the "too big to fail" banks will sink if they hit a big enough iceberg. Leverage was a notable catalyst in the Global Financial Crisis (GFC) - but it wasn't the only one...
Systemic risk was a huge factor in the GFC. When the first few financial institutions started to fall, the resulting domino effect that followed disrupted the global financial market, sparking chaos around the world. Growing panic resulted in a “run on the banks”; people showing up in droves, attempting to withdraw their funds. We saw this in New Zealand, to a degree. When word got around about the collapsing finance companies, the ensuing panic disrupted the entire credit market. It creates a self-fulfilling prophecy: if large enough group believe there is credible risk that a financial institution will fail, their attempts to protect themselves will turn credible risk into near certainty.
Banks, and finance companies for that matter, have never really been that great at honesty and transparency. Again, we only have to point to the GFC to exemplify this. At Harmoney, honesty and transparency are some of our biggest focuses. We want to hand the power back to you; you get to choose exactly where your money goes, and exactly what risks you expose your money to. We’re completely open about what those risks are, and utilise leading-edge risk management techniques.
Fractionalisation is a fundamental part of Harmoney. At the moment, we’re the only company planning to use fractionalisation when we launch peer-to-peer lending in New Zealand. It’s one of the most powerful risk management tools we provide for our investors. We divide each loan into $25 "notes", allowing investors to diversify their portfolio into tens, hundreds or even thousands of loans, each of which they have the power to individually select. This means that the small percentage of defaults we expect to occur will have a minimal effect on an investor's portfolio as a whole, if they are fully diversified. With defaults typically occurring around 10-18 months in, the small percentage of expected defaults often wouldn't result in the loss of the whole $25 note.
Our leading-edge, cloud based technology is scaleable, secure and proven. It provides a responsive user experience that is fully automated. What that boils down to is this: It’s quick, it’s easy and it’s safe. It means you don’t need to come into a branch, and when branches are one of the biggest costs for bank, it means our operating costs are much lower. That money goes to our customers instead.
There’s not a lot of value for money in the banks these days; not for customers, at least. When they’re making 10-12 times more profit on personal loans and credit cards than any other service, it’s about time to make some changes.
Our CEO, Neil Roberts, got the closing note in the Stuff article. Roberts is confident that New Zealanders are early adopters, and will quickly realise that peer-to-peer simply opens a well-established market to the wider public. “It takes time to build any market, but all of this makes for a compelling offer.”