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Banking 2.0

7th April 2015

The dramatic events of October 2008 changed the game for banks globally; over-leveraged and under-capitalized, lenders throughout the developed world have embarked on a lengthy and painful period of rationalization. Small and medium-sized enterprises have been an unintended casualty of this balance sheet repair, with net lending to SMEs in the US still down significantly from levels before the Great Recession. According to the most recent Federal Reserve bank stress tests released last month, average ‘core tier 1’ ratios, a measure of financial safety, have risen from 5.5% in Q1 2009 to 12.5% in Q4 2014. This increase has been driven by a reduction in assets as the largest banks attempted to reduce their outsized footprints. As the late comedian Bob Hope is said to have quipped, “a bank is a place that will lend you money if you can prove that you don’t need it.”

At the same time, the wall of capital flowing from central banks’ ‘quantitative easing’ programs has significantly compressed yields across the curve. Savers in the US can hope to make virtually nothing at current bank deposit rates, and with 2-year US government bonds currently yielding 0.5% aggrieved savers have nowhere to turn for meaningful income.

One corner of the financial markets has been quietly developing a solution: disintermediation. For those seeking an acceptable return, and those shut out of reasonable credit, peer-to-peer lending offers to connect savers and borrowers directly, crowdsourcing funding while dramatically reducing the need for a bank. P2P significantly narrows the spread between lender and borrower, with depositors at one platform, Funding Circle, expecting 6.5% after fees and defaults. There is of course no free lunch and P2P, like any such asset, bears risk – the recent economic environment has not stressed the potential for defaults and loans can last up to five years, bringing illiquidity. However, there is an active secondary market (at this time), and if portfolios are appropriately diversified we feel that P2P is an attractive asset class to those who seek yield.

The P2P market in the US is rapidly expanding to serve SMEs. Last year Funding Circle, which originated in the UK, merged with Endurance Lending Network in the US to begin providing loans to US small businesses. In addition, the largest P2P lender, Lending Club, teamed up with Google earlier this year to begin offering loans to Google’s SME partners. Combined with more robust regulation of P2P lenders by the SEC and the FCA, we believe now to be an opportune time to deploy capital otherwise earmarked for steady income generation.