We need to change direction - our housing credit bubble is leaving business behind

Interesting article by Christopher Joye in the AFR today - see below - calling out our policy makers for spurring on our consumer credit bubble. Businesses are left behind.

It really matters that credit should be available for business purposes to finance growth. But our system allows banks to leverage house loans 40 times compared to 'only' 10 times for an SME loan.

So small-medium sized businesses that employ must of us don't get a look in...unless they own some real estate of course.


Our banks only want to lend against houses. Since 2013, only 11% of new business lending in Australia has gone to small businesses with little growth:

  • Most of the $900bn of loans outstanding to businesses goes to the big end of town
  • $269bn lent to SMEs is swamped by over $1,500bn in residential mortgage lending
  • Banks see SMEs as a critical source of cheap deposits – SME deposits far outweigh SME loans
  • But SMEs employ the bulk of our workforce

Due to global regulatory capital rules (Basel III), mortgages are more than 3 times more profitable than SME loans:

  • Real estate carries a risk weighting of 25% but SME loans require 100% (75% if backed by real estate)
  • Banks have effectively withdrawn from their original purpose: facilitate commerce

Meanwhile SME growth and employment is constrained by lack of cashflow facilities:

  • Banks will only lend to SMEs with real estate security which is a problem in a service based economy
  • The ATO/taxpayer is forced to act as lender of last resort (ATO is owed $12.5bn in tax by SMEs and growing rapidly)
  • Tight cashflow holds back growth:

The RBA is blowing the mother of all bubbles

Can history be repeated? A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966". RICHARD DREW

Can history be repeated? A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966". RICHARD DREW

by Christopher Joye

With US employment growth again surprising forecasters and the jobless rate declining to a boom-time 4.7 per cent, below "full-employment", the question is whether central banks, and the Federal Reserve in particular, are "behind the curve".

In research this week Goldman Sachs assessed this using a framework previously advocated by Fed chair Janet Yellen. Goldman found "the Fed's current policy stance is about 1 percentage point easier than prescribed by a Taylor rule that uses a depressed neutral rate" and about 3 percentage points easier when adopting a more normal neutral cash rate of about 4 per cent. The latter assumption "implies that the current policy stance represents the largest dovish policy deviation since the 1970s", which coincided with an inflation break-out.

"The implication that current policy is somewhat 'too easy' is consistent with the fact the [US] financial conditions index remains easier than average and is still delivering a positive growth impulse at a time when the Fed is trying to impose deceleration," Goldmans said.

The investment bank warns "history counsels caution about falling behind" with the experience of the mid 1960s suggesting that inflation increases much more quickly at very low unemployment rates. Back then, years of benign inflation gave way to a sudden spike as the Fed wilted under political pressure not to aggressively tighten rates. A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966".

Federal Reserve Chair Janet Yellen: The third rate hike since the 2007-2009 recession was well telegraphed. Andrew Harnik

Could history repeat itself? Much hinges on policymakers' humility. Central bankers are not fond of acknowledging errors, often rationalising ex post facto via the meme that "this time is different", which can be exacerbated by the desire to propagate an image of infallibility. Remember the once-lionised monetary maven Alan Greenspan?

These risks have certainly spooked interest rate investors, although the adjustment process has a way to run. After the second biggest fall in fixed-rate (as opposed to floating-rate) bond prices in modern history in the December quarter, the spectre of a Fed hike in March - duly delivered this week - has lifted long-term rates further. 

Will RBA ever lift again?

In Australia the 10-year government bond yield is nearing 3 per cent, significantly higher than the sub-2 per cent level traders—gripped by "cheap money forever" fever—priced in September 2016. Current 10-year yields are, however, still miles below the 5.5 per cent average since the Reserve Bank of Australia started targeting inflation in 1993.

Some of the best interest rate traders I know, almost all of whom have never experienced a proper inflation cycle, genuinely believe the RBA "will never hike again".

The problem with a supercilious central bank is the ensuing risk insouciance increases the probability of mistakes. A classic example was a speech given by the RBA's new head of financial stability this week.

According to this revisionist narrative the global financial crisis (GFC) "hasn't fundamentally changed the way we think about financial system stability". The RBA is evidently so sensitive to allegations it has failed to heed the lessons of the GFC—by blowing the mother of all bubbles with excessively cheap money—that it felt compelled to repeat the mantra the crisis had not altered its approach on five separate occasions in the speech. There are demonstrable flaws in this fiction.

First, the RBA never came close to anticipating the GFC. Its financial stability guru, Luci Ellis, published a paper in 2006 arguing"the most important lesson to draw from recent international experience is that a run-up in housing prices and debt need not be dangerous for the macroeconomy, was probably inevitable, and might even be desirable".

Ellis maintained that "the experience of Australia and the UK seems to suggest booms in housing price growth can subside without themselves bringing about a macroeconomic downturn". Two years later the 33 per cent drop in US house prices would trigger the deepest global recession since the great depression.

Second, the GFC necessitated a raft of policy responses that had never been seriously contemplated before, which have transformed the way we think about dealing with shocks and the unanticipated consequences. Contrary to the recommendations of the 1997 financial system inquiry, the Commonwealth guaranteed bank deposits and bank bonds for the first time. The RBA agreed to buy securitised mortgage-backed portfolios via its liquidity facilities, which it had never done, and Treasury independently acquired $16 billion of these loans in the first case of local "quantitative easing".

Banks borrowed more money on longer terms from the RBA than anyone previously envisioned, which led the RBA to create a new bail-out program called the committed liquidity facility. In emergencies banks can now tap over $200 billion of cash instantly at a cost of just 1.9 per cent that makes trading while insolvent an impossibility.

A central tenet of pre-GFC regulation--attributable to the 1997 Wallis Inquiry—was that taxpayers should never guarantee any private firm for fear of inducing "moral hazard". This is the "heads bankers win, tails taxpayers lose" dysfunction that emerges when governments insure downside risk. The RBA has since conceded that the crisis bail-outs unleashed unprecedented moral hazards, such as too-big-to-fail institutions, that require new mitigants.

The Australian Prudential Regulation Authority used to allow the major banks to leverage their equity 65 times when lending against housing because these assets were presumed to be nearly risk-free. Since the 2014 financial system inquiry APRA has been persuaded to deleverage the major banks' home loan books to merely (!) 40 times.

In 2013 the RBA was publicly dismissive of foreign regulators' efforts to contain credit growth via so-called macroprudential interventions to cool hot housing markets. One and a half years later APRA belatedly sought to cauterise the housing boom the RBA's 2012 and 2013 rate cuts precipitated with light-touch macroprudential jaw-boning.

Of course in 2017 the RBA has a different version of events. Apparently it has always seen "macroprudential policy as part and parcel of the financial stability framework". It turns out that "in 2014 the Australian regulators [presciently!] took the [rear-]view that risks were building in the residential housing market that warranted attention".

Actually, none of APRA's December 2014 announcements had any impact until well into 2015 (two years after the boom started) and they proved to be woefully inadequate. This column revealed, for example, that many banks had completely ignored APRA's minimum serviceability tests on home loans.

Good risk management requires intellectual honesty, which is missing in action among those overseeing the "wonder down under".

Read more: 

Don't Bank on it! Tips on financing business growth

Established businesses that are expanding rapidly face challenges from all sides. They may be winning large contracts with slow-paying major customers, recruiting at a fast pace, experiencing increased competition and market pressures, they may need to invest in production, marketing and development almost simultaneously and the management team may also be looking at new ventures and territories.

If this sounds like you, then you will be familiar with the sensation of having to keep all the plates spinning, while also professionalising your business – perhaps taking on greater financial or managerial clout. You might be recruiting at director-level, while also cementing existing relationships with everyone from new recruits to your oldest customers.

As a thriving, established business, you have already established your credentials but to maintain growth, the business requires more working capital investment.

Most growing mid-sized businesses with revenue of $10-30 million could really do with another $1 million to fund growth. But where do you find it?

Raising equity from business angels does not make sense for most established businesses. Few owners are happy to give up control of their business. Similarly, few businesses fit the criteria of business angels who look for unique companies with strong growth potential and solid prospects for a sale of the business in the medium term.

At the other end of the spectrum is your bank. Unfortunately, banks require real estate security so it will be impossible to obtain meaningful working capital finance from a bank without pledging a substantial amount of real estate. Business owners waste a lot of valuable time looking for an overdraft from their bank.

Filling the void, peer-to-peer business loans can provide an alternative source of finance. These sources of funding are thriving but are typically only able to provide up to $150k on an unsecured basis. The costs are quite high and the need to repay monthly over a 6 month term makes even less sense for growing businesses.

However, there is another key option: your existing sales ledger can also provide a valuable source of cashflow with larger facility sizes ($1m+) than available from unsecured lenders.

Historically, the only option was factoring which involves onerous contracts and the consent of your customers. An ancient model, literally as it was invented around 4,000 years ago in Mesopotamia, it doesn't work for most businesses.

Now there is a much better way - confidential invoice trading. Online invoice trading platforms connect businesses with a pool of investors who will advance funds against existing valid invoices. Instead of waiting out long payment periods, businesses trade their invoices and receive a percentage of their value – around 80% - with a minimal waiting time. All without involving your customers.

Online or alternative invoice finance improves on the traditional approach to invoice finance and factoring considerably.

It is possible to trade a single invoice, rather than surrendering a complete sales ledger to a provider. The technology platform keeps costs low, and decisions on creditworthiness are rapid. Generally, platforms approve businesses within a day, provided they can produce bank statements and accounts. Once invoices are validated funds can be made available straightaway. Costs come in at around one to three per cent, but over time this kind of finance becomes more cost-effective, with discounts for subsequent invoices.

Invoice finance is a useful means of improving cash flow and unlocking access to working capital. It is also particularly helpful for businesses considering export markets where payment cycles can be unpredictable particularly in the short term.

Check out the alternatives to banks. Speak to a finance broker or your accountant or enquire directly with providers that seem to fit your needs.

Invoice trading is booming in Australia, according to a report by KMPG, University of Sydney, Cambridge University and Tsinghua Graduate School

As reported in The Australian today, in the first Asia-Pacific report surveying Alternative Finance published this week, it is notable that, relative to consumer lending, alternative business finance and, in particular invoice trading, has developed much more strongly in Australia than in the US and the UK.

We are quoted in the article as noting that this underlines the exceptionally under-served nature of the Australian small business lending market, which at the recent Altfi Summit in Sydney was estimated to be seeking an additional $95bn of finance.

This trend is also reflected in RBA lending statistics which show property loans since the GFC have grown by $538.7bn (+54%) while business lending has increased by just $72.5bn (+9%).

(RBA Statistics: Business Credit Seasonally Adjusted: $765.5bn in December 2008 to $838.0bn; Housing Credit (Owner Occupied and Investor) $992.9bn to $1,531.6bn)

KPMG’s endorsement of invoice trading will go a long way, but regulation is what really builds trust in a sector. The truth is, unlike consumer lending, a sandbox won’t accelerate the development of innovative new business finance products – but increased involvement from and endorsement by the gamekeeper will accelerate business adoption.

The government’s most pressing need now is to accelerate the adoption of alternative finance by SMEs, which would provide a kick-start to our economic growth. Introducing disclosure standards as to the cost of finance and terms and conditions of finance – similar to comparison rates for mortgages – is a simple step to take, but would dramatically change the reputation of the sector.

It’s clear that the regulatory environment needs a 21st century approach, and the government seems to be aware of this, but we are all waiting to see words turn into action. We’re in a similar position to when the SMSF market first emerged – the regulators had to rapidly come up with a new approach then, and the need is even more pressing now with the increased speed of the development of new business finance products.

As Paul Keating said: “When we laid the foundations for the current superannuation system in the 1991 Budget, I never expected Self Managed Super Funds (SMSFs) to become the largest segment of super. They were almost an afterthought added to the legislation as a replacement for defined benefit schemes.” 

Time to get wriggle on!



Why Government needs to get involved in fixing business lending

Interesting views from a notable economist, Joseph Stiglizt, in promoting his book, Freefall: 

I believe that markets lie at the heart of every successful economy but that markets do not work well on their own. In this sense, I'm in the tradition of the celebrated British economist John Maynard Keynes, whose influence towers over the study of modern economics.

Government needs to play a role, and not just in rescuing the economy when markets fail and in regulating markets to prevent the kinds of failures we have just experienced. Economies need a balance between the role of markets and the role of government – with important contributions by non-market and non-governmental institutions. In the last 25 years, America lost that balance, and it pushed its unbalanced perspective on countries around the world.

We should take this moment as one of reckoning and reflection, of thinking about what kind of society we would like to have, and ask ourselves: are we creating an economy that is helping us achieve those aspirations?

We now have the opportunity to create a new financial system that will do what human beings need a financial system to do; to create a new economic system that will create meaningful jobs, decent work for all those who want it, one in which the divide between the 'haves' and 'have-nots' is narrowing, rather than widening; and, most importantly of all, to create a new society in which each individual is able to fulfill his aspirations and live up to his potential, in which we have created citizens who live up to shared ideals and values, in which we have created a community that treats our planet with the respect that in the long run it will surely demand. These are the opportunities. The real danger now is that we will not seize them. 



Basel Committee's new approach: banks will turn further away from SME lending

The Basel Committee released its second consultative document on Revisions to the Standardised Approach for credit risk in December (comments due by 11 March 2016).

There has been little or no commentary about its impact on SME lending - we believe that the effects will be far reaching.  

The committee pulled back from the penal ‘negative equity =>150% risk weighting’ approach that was previously proposed. Now they propose a general 85% risk weighting. This compares with a current 60% weighting so is still bad news for SMEs looking to raise finance from banks.

There are statements in the document about having to apply 100% risk weighting if due diligence requires it. The proposed revision to lease accounting (IFRS 16) could be a factor here.

So the future of SME lending remains in a state of flux, with the 'Big 4' IRB version yet to be released. The outcome is likely to have a major impact on SME lending by banks, especially as it affects mid-sized businesses that drive growth and jobs across Australia.

SMEs now only represent 15% of new business lending by banks and outstanding loans have fallen to 30% of all business lending (early ‘90s – 50%).

It is already quite uneconomic for banks to lend to SMEs and becoming more so. We believe that this downward trend is set to continue, as is happening globally.

Sound management of risks related to money laundering and financing of terrorism

Timely updated guidance from the Basel Committee on account opening. Just as important for P2P lenders as banks.

The three lines of defence

19. As a general rule and in the context of AML/CFT, the business units (eg front office, customer facing activity) are the first line of defence in charge of identifying, assessing and controlling the risks of their business. They should know and carry out the policies and procedures and be allotted sufficient resources to do this effectively.

The second line of defence includes the chief officer in charge of AML/CFT, the compliance function but also human resources or technology.

The third line of defence is ensured by the internal audit function.

20. As part of the first line of defence, policies and procedures should be clearly specified in writing, and communicated to all personnel. They should contain a clear description for employees of their obligations and instructions as well as guidance on how to keep the activity of the bank in compliance with regulations. There should be internal procedures for detecting and reporting suspicious transactions.

21. A bank should have adequate policies and processes for screening prospective and existing staff to ensure high ethical and professional standards. All banks should implement ongoing employee training programmes so that bank staff are adequately trained to implement the bank’s AML/CFT policies and procedures. The timing and content of training for various sectors of staff will need to be adapted by the bank according to their needs and the bank’s risk profile. Training needs will vary depending on staff functions and job responsibilities and length of service with the bank. Training course organisation and materials should be tailored to an employee’s specific responsibility or function to ensure that the employee has sufficient knowledge and information to effectively implement the bank’s AML/CFT policies
and procedures. New employees should be required to attend training as soon as possible after being hired, for the same reasons. Refresher training should be provided to ensure that staff are reminded of their obligations and their knowledge and expertise are kept up to date. The scope and frequency of such training should be tailored to the risk factors to which employees are exposed due to their responsibilities and the level and nature of risk present in the bank.

22. As part of the second line of defence, the chief officer in charge of AML/CFT should have the responsibility for ongoing monitoring of the fulfilment of all AML/CFT duties by the bank. This implies sample testing of compliance and review of exception reports to alert senior management or the board of directors if it is believed management is failing to address AML/CFT procedures in a responsible manner. The chief AML/CFT officer should be the contact point regarding all AML/CFT issues for internal and external authorities, including supervisory authorities or financial intelligence units (FIUs).

23. The business interests of a bank should in no way be opposed to the effective discharge of the above-mentioned responsibilities of the chief AML/CFT officer. Regardless of the bank’s size or its management structure, potential conflicts of interest should be avoided. Therefore, to enable unbiased judgments and facilitate impartial advice to management, the chief AML/CFT officer should, for example, not have business line responsibilities and should not be entrusted with responsibilities in the context of data protection or the function of internal audit. Where any conflicts between business lines and the responsibilities of the chief AML/CFT officer arise, procedures should be in place to ensure AML/CFT
concerns are objectively considered at the highest level.

24. The chief AML/CFT officer may also perform the function of the chief risk officer or the chief compliance officer or equivalent. He/she should have a direct reporting line to senior management or the board. In case of a separation of duties the relationship between the aforementioned chief officers and their respective roles must be clearly defined and understood.

25. The chief AML/CFT officer should also have the responsibility for reporting suspicious
transactions. The chief AML/CFT officer should be provided with sufficient resources to execute all responsibilities effectively and play a central and proactive role in the bank’s AML/CFT regime. In order to do so, he/she must be fully conversant with the bank’s AML/CFT regime, its statutory and regulatory requirements and the ML/FT risks arising from the business.

26. Internal audit, the third line of defence, plays an important role in independently evaluating
the risk management and controls, and discharges its responsibility to the audit committee of the board of directors or a similar oversight body through periodic evaluations of the effectiveness of compliance with AML/CFT policies and procedures. A bank should establish policies for conducting audits of (i) the adequacy of the bank’s AML/CFT policies and procedures in addressing identified risks, (ii) the effectiveness of bank staff in implementing the bank’s policies and procedures; (iii) the effectiveness of compliance oversight and quality control including parameters of criteria for automatic alerts; and (iv) the effectiveness of the bank’s training of relevant personnel. Senior management should ensure that audit functions are allocated staff that are knowledgeable and have the appropriate expertise to conduct such
audits. Management should also ensure that the audit scope and methodology are appropriate for the bank’s risk profile and that the frequency of such audits is also based on risk. Periodically, internal auditors should conduct AML/CFT audits on a bank-wide basis. In addition, internal auditors should be proactive in following up their findings and recommendations.18 As a general rule, the processes used in auditing should be consistent with internal audit’s broader audit mandate, subject to any prescribed auditing
requirements applicable to AML/CFT measures.

27. In many countries, external auditors also have an important role to play in evaluating banks’ internal controls and procedures in the course of their financial audits, and in confirming that they are compliant with AML/CFT regulations and supervisory practice. In cases where a bank uses external auditors to evaluate the effectiveness of AML/CFT policies and procedures, it should ensure that the scope of the audit is adequate to address the bank’s risks and that the auditors assigned to the engagement have the requisite expertise and experience. A bank should also ensure that it exercises appropriate oversight of
such engagements.

Why is funding for small businesses so severely constrained?

Most small businesses turn to bank financing to fund their operations. However, lending by banks is often limited because understanding small businesses requires more time and expertise than the more standardized consumer business.

At the same time, the traditional relationship-based corporate banking model is costly to operate in dealing with small business, given the smaller loan size. Further, information asymmetry as a result of the lack of supporting financial information infrastructure limits the ability to lend. Small businesses often lack the required data, such as a history of audited statements for a bank to appropriately assess its cash flow situation.

More generally, the high intrinsic risk of SMEs often exceeds banks’ risk appetite. This hesitation is further amplified by regulation, such as Basel III, which imposes higher capital requirements for (riskier) small business loans, compared to loans extended to states or home owners.

Over past years, banks have thus further decreased their lending exposure to SMEs while the costs of borrowing have increased for SMEs. In the US, SME loans as a percentage of all bank business loans fell from 35% to 24%. In the Eurozone, borrowing costs for SMEs as spread over larger loans increased by 150%.

The Future of FinTech: A Paradigm Shift in Small Business Finance, October 2015

APRA ignores our banks' offshore funding elephant - 53% of GDP

Interesting perspective from Macrobusiness

February 11, 2016 

By Leith van Onselen

APRA chair, Wayne Byres, appeared before Senate Estimates today and gave the Australian financial system a clean bill of health, stating it remains “fundamentally sound”. From Business Spectator:

Appearing before a senate committee this morning, Australian Prudential Regulation Authority (APRA) chair Wayne Byres said nothing that had occurred in the last few months had changed his assessment.

“As you would expect, we are keeping a close eye on global developments, but the declines in stock markets and the increases in credit spreads that have occurred in recent times have been quite manageable given the sector’s strong starting position,” Mr Byres said.

“Indeed, this is why we require regulated institutions to maintain buffers over and above our minimum requirements — so that this sort of volatility can be absorbed without any significant stress.”

No mention, of course, of the Australian banks’ extreme reliance on offshore borrowings to help fund their mortgage book.

As shown in the next chart, the banks’ offshore borrowings hit an unprecedented 53% of GDP in the September quarter of 2015, and have been a key ingredient behind the banks’ growing loan books – mostly mortgages – which hit a record 210% of GDP as at September 2015:

The situation since then will no doubt have worsened further given the ongoing solid credit growth, which continues to dwarf that of both incomes and nominal GDP.

All of which is fine until offshore credit markets seize and dramatically raise the cost of funding, as appears to be happening currently (albeit in the early stages).

The funding situation would also deteriorate in the event that Australia’s sovereign credit rating is downgraded, automatically downgrading the banks’ credit ratings in the process. Given the rapidly deteriorating Budget deficit, it is a matter of when not if.

Why do our regulators continually ignore the gigantic foreign borrowings underpinning Australia’s mortgages and the housing market?

Why SME lending doesn't make sense for our banks, according to the RBA

It's time that our banks started to be upfront about lending to small businesses. It doesn't make any sense for them and they only do it to access cheap deposits.

The Reserve Bank of Australia issued an interesting report in October 2015, the main focus being on leveling the playing field in residential mortgages between the Big 5 banks and the smaller ones.

However, it also succinctly highlighted why SME lending is so unattractive for our banks. They need 4 times more of their own capital to lend to a small business than the amount required to advance a residential mortgage loan. Add in the costs of dealing with the complexity of business lending and it is clear why it is such an unattractive business for them.

And with the looming regulatory capital changes ahead, SME lending is going to become a lot less attractive: up to 10 times less in fact.

Thankfully, the Alternative Finance market is now developing but, if not actively supported by our policy-makers,  it will take too much time to plug the gap that really needs filling now, not in 5 years time.

Let's hope Canberra is on to this.


End of SME business banking as we know it

Currently, banks are required to allocated 4 times more of their own shareholders' capital against Small Business Loans than required for residential mortgages.

As bank management teams focus on maximising Return on Equity (RoE), this makes it hard for banks to justify lending to small businesses. However, it's acceptable as long as they receive more in the way of cheap deposits from other small businesses.

Now the regulators are discussing increasing the amount of capital that banks must set aside against Small Business Loans - it could be 5 times more than the current requirement (300% risk weighting versus about 60% currently). This looks like the end of Small Business Banking as we know it.

basel 4
basel 4

These proposals would apply to smaller banks that are required to apply the Standardised Approach. We await the proposals for major banks but expect a similar approach.

SME business lending: the trend in favour of P2P lending is clear #ideasboom

Basel III regulatory capital rules favour mortgages 4x more than business lending so the trend in favour of P2P lending is clear:

  • SME bank loans represented only 15% of new business loans in Australia last year (Source: RBA)
  • SME loans by US major banks have fallen by 40% since 2006 (Source: Wall Street Journal)
  • Bank lending to London’s SMEs plummeted 40% in the last year but an estimated £350m of SME finance was completed through peer-to-peer lending in 2015 (Source: British Bankers’ Association).   

P2P finance has “the potential to become a game changer for small businesses and brokers. Because FinTech solutions are efficient and effective at lower scale, small businesses will be one of the main beneficiaries of FinTech’s disruptive power.” World Economic Forum Report, October 2015

Lending Club paves way for rivals: low cost is the critical success factor

An interesting article in the Financial Times analysing the bumpy ride for Lending Club, the leading US P2P lender, in its first year post-IPO. Like Amazon, offering the lowest cost is key to success.

January 26, 2016 11:15 am

Lending Club paves way for rivals

Ben McLannahan in New York

Larry Summers was effusive, when asked in December 2014 to comment on the stock market debut of Lending Club. Shares in the San Francisco-based group leapt more than 50 per cent on day one on the New York Stock Exchange, as investors scrambled to get exposure to a branchless lender that had vowed to “transform” the banking system.

“It’s a good day for Lending Club,” said the former US Treasury Secretary, part of an all-star board of directors assembled by the company, which connects people seeking money with people willing to lend. “It’s not the beginning of the end, but it is perhaps the end of the beginning.”

But in the 13 months since, the revolution has not yet come to pass. Although Lending Club has grown strongly, more than doubling revenues last year while pumping out billions of dollars of personal loans, the stock has mostly fallen amid fears of rising competition and tougher regulation. And far from displacing the old bricks-and-mortar banks, Lending Club appears to have galvanised them into action, spurring copycat services and all manner of alliances between traditional lenders and the upstarts.

Mr Summers himself has been a seller of the stock, offloading about 120,000 of his 1m shares since September, according to public disclosures logged by Bloomberg. A spokesperson said that Mr Summers has a “substantial concentration of his net worth” in the stock, so “made a decision when the company went public to diversify and established a regular selling programme”.

So poorly have Lending Club’s shares performed, in fact — down 56 per cent last year, and another 28 per cent this year — that other online lenders such as Prosper and SoFi appear to have cooled on the prospects of going public.

Underwriters sold Lending Club as if it were a web platform in a similar vein to LinkedIn, Facebook or Alibaba, said one Wall Street banker, speaking on condition of anonymity. “The reality is that it trades more like a bank.”

Michael Tarkan, a Washington, DC-based analyst at Compass Point, argues that intense competition and an “inhospitable” policy environment will continue to weigh on the shares.

Lending Club and its instalment-lending peers are facing new levels of oversight by the Consumer Financial Protection Bureau, beginning later this year, for example, and a sector-wide probe into pricing and credit quality by the California Department of Business Oversight, due to complete in March. And later this week federal lawmakers are due to start debating laws on terrorism financing — an effort that could result in extra scrutiny for online lenders, given that one of the killers in December’s shootings in San Bernardino had taken a big loan from Prosper.

Meanwhile, regional banks such as Citizens and SunTrust have pushed more deeply into personal loans, while non-banks such as are moving on to Lending Club’s core patch of debt consolidation. Even Goldman Sachs, the New York investment bank, is preparing to launch a consumer-focused online venture.

A survey by the Office of the Comptroller of the Currency last month found that banks expected the risk profile of their personal loan portfolios to rise this year by the largest amount since 1998 (excluding the crisis) — implying a direct assault on the web-based lenders.

“Lending Club is offering a commoditised loan product,” said Chris Gamaitoni, an analyst at Autonomous Research. “We don’t see a moat that cannot be attacked by large peers.”

Renaud Laplanche, Lending Club’s co-founder and chief executive, told the Financial Times that increased regulatory interest in online lending does not imply a crackdown on the sector, and argued that the company has beaten back waves of challengers since its founding nine years ago.

As for the stock price, he said that it is only a matter of time before sentiment turns. He noted that it took about a year for Facebook stock to start to climb after the company’s initial public offering in May 2012.

In the meantime, he added, an imminent announcement of entry into a new product area, perhaps car loans, could rekindle some excitement. He hinted the move could be taken in conjunction with one of the traditional banks — similar to JPMorgan Chase’s tie-up last month with OnDeck Capital, a specialist in lending to small businesses.

That deal was seen as an admission from the biggest US bank by assets that it could not issue or service loans as cheaply and as efficiently as OnDeck, an online lender. But equally, it was a sign that OnDeck needed the customer connections and the steady funding of Chase, the bank’s huge retail network. Since signing the partnership early last month, OnDeck’s stock has steadied, outperforming the financials sector.

“Think of the cost of credit, which is basically the cost of operations plus the cost of capital; Lending Club has the lowest possible cost of operations, with technology and automation, and banks have very low cost of capital,” said Mr Laplanche. “I think the partnerships between marketplace lenders and banks make tons of sense.”

Bank lending plummets for London SMEs

Bank lending to SMEs is in long term decline for many reasons. It will be interesting to see how the Australian SME finance market develops over the next year or two.



The capital’s small businesses are abandoning traditional bank funding and embracing alternative finance, according to new figures from the British Bankers’ Association. 

Whilst bank lending London’s SMEs has plummeted 40% in the last year, the capital’s companies raised an estimated £350m through peer-to-peer lending in 2015.   

Statistics from the British Bankers’ Association show that the value of all newly approved loans and overdrafts to London SMEs in Q3 of 2015 was down 40% on 2014 totals, from £1.7bn to just over £1bn. 

The average London SME has now less than £20,000 borrowed from their bank – a record low. In 2011 the average London business had £28,000 borrowed from their bank.  

Roz O’Brien is the Company Director of Pixel Projects, a technology business born and based in London. The company provides cutting edge audio visual installations to the world’s largest internet companies.

“Working with banks can be a slower, cumbersome process; and that doesn’t always suit our business model”, said O’Brien. “The tech sector works quickly and efficiently, it’s a fast-paced environment; and our funding setup needs to reflect that. We can’t wait on a banks’ response to a funding application.“ 

Pixel Projects have raised over £9 million worth of project funding through peer-to-peer lender MarketInvoice. “It’s helped our business grow faster than we otherwise could have – we get funds quickly, as they’re needed”, said O’Brien. 

“It feels only natural for us to embrace new technologies in how we finance our business,“ O’Brien added. “It’s clear that the world of finance is changing, and tech companies like us should be the first to embrace this change.“

Anil Stocker, CEO & Co-founder of MarketInvoice commented: “Banks have grown increasingly reluctant to lend to SMEs, who see business lending as high risk, low return practise. Approvals for loans and overdrafts have been hard to come by – despite direct government incentives such as the Funding for Lending Scheme.“ 

“At the same time the city’s businesses have recognised peer-to-peer lending as a better, more efficient way of financing their growth. We’re supporting a lot of the fastest growing companies in the capital – dependable cashflow is rocket fuel for these businesses."

SMEs account for only 15% of new lending

Article in today's Australian by Michael Bennett


Banks vie for credit growth as non-mining sector picks up

The nation’s biggest banks are jostling for a bigger slice of the business lending market as analysts tip a solid year of credit growth as the non-mining parts of the economy improve.

After two months of healthy demand, business credit growth flatlined in November, dragging down annual growth to 6.2 per cent, from 6.6 per cent, according to latest Reserve Bank data.

But apart from October and September, 6.2 per cent remains the strongest since February 2009 and economists expect the revival in recent months hasn’t petered out.

Even so, the latest figures compare to the peak in December 2007 of 24 per cent, the strongest since the prior boom in December 1988. In contrast, demand bottomed in November 2009 at negative 7.5 per cent and remained muted until recently.

Our perspective:

Per the RBA, as at Sept 2015 and published on 17 Dec, total business lending was up a healthy 9.6% to $857bn.

85% of the $75bn growth was in loans over $2m which totalled $596bn as at 30 Sept.

Of the $75bn in growth, 40% came from 'Other' industries.

Finance and insurance accounted for 25%, Wholesale trade, retail and transport 18%, Construction 6%, Manufacturing 10%, Mining 0%, Agriculture 1%.

Lending in the critical $500k - $2m bracket - ie SMEs - grew by 5.1%. How much of all of this was mortgage lending? We do not know.

Basel III regulatory capital rules favour mortgages 4x more than business lending. As a result, our banks behave like building societies - understandably.

The Fintech sector can fill the gap but it needs to become much bigger to move the needle on growth.



Why the UK Gov is fully engaged with Peer-to-Peer Lending - Financial Times

Treasury sings praises of peer to peer lenders

City minister Harriett Baldwin has branded peer to peer lending a “brilliantly innovative new form of finance – which we want to see continue to grow and evolve.”

In a speech to the Peer-to-Peer Finance Association (P2PFA) Summit in London yesterday (21 October), Ms Baldwin said peer-to-peer lending can plug the funding gap for small businesses.

Ms Baldwin said: “I am proud of the fact that the UK has the largest P2P and alternative finance sector in Europe. We’ve worked hard for that.

“We knew, for example, that for the sector to mature, it would be important to bring it within the correct statutory framework. Proportionate regulation will protect consumers lending and borrowing via a P2P platform and allow the sector to continue to grow.

“P2P platforms and fintech provide competition, ideas, and technology– making people’s lives better and the markets more effective. When you do well, your businesses flourish. Excellence breeds excellence.

“Customers have the services they need to meet their aspirations. And this country becomes better off, as a result of all this activity taking place here in the UK. We are ambitious, because you are ambitious too. I can sense the energy in this room.

“The businesses here – from Funding Circle to RateSetter to Zopa – are some of the most innovative in Europe.”

The MP for West Worcestershire highlighted the fact as part of the savings package announced in the March 2015 Budget, the Conservatives confirmed they would expand the range of products that can be held in stocks and shares Isas to include loans made through P2P platforms.

Holding P2P loans within an Isa will mean that interest received on the loans will not be subject to tax. These rules will come into force from the start of the next tax year, on 6 April 2016.

From earlier this year, investors in P2P platforms have also been allowed to offset any losses from P2P loans which go bad against other P2P income, reducing the amount of income tax that the individual has to pay on the P2P interest.

Ms Baldwin said: “The objective here is to level the playing field, and make P2P more attractive to investors by equalising the advantage banks and other investment products have over them.

“We have also been consulting with industry on the implementation of new withholding tax obligations, to apply across all P2P lending platforms from April 2017.

“I appreciate the engagement this sector has had with the government on this issue, and we will be publishing our response soon – watch this space.”

Ms Baldwin’s gushing praise for P2P came after new research revealed that 40 per cent of people would consider investing in peer to peer when the Innovation Isa launches next April.

A survey conducted by One Poll among 500 active investors by lending platform ThinCats found that the new Isa will expand the market by as much as a third, as investors seek to utilise the tax advantages available to them.

During her speech Ms Baldwin also talked about pension freedoms and said what we will be seeing over the coming years is a fresh wave of customers who are much better-informed, and much keener to exercise these new powers – not least, through investing.

Ms Baldwin said: “A real opportunity for the financial services sector to deliver for them.”


The Uber and Airbnb of Confidential Growth Capital - the Smart Way to Grow

invoice finance re-inventedMaking sense of the business finance market

The first thing to know about how we work is that we are in the business of matching high quality, growth companies with a strong network of investors but only as and when needed and always on the very best terms that can be found.

This is unusual. We are creating a new category of growth capital based on substantial experience of working with highly successful companies.

Why are our terms the very best on offer?

We do not compete with banks. Bank finance is secured on property ('fixed assets') so it is always going to be the lowest cost finance but it is not comparable. It’s basically a more expensive mortgage than a typical residential mortgage. Or it could be equipment/vehicle leasing from a bank or other large finance provider. When you’ve exhausted this option, where can you go for real growth capital?

Equity investors, if you can attract them, will need a big say in how you run your business and will need an exit route ie sale of your business. And a great return for the risk and complexity.

We are plugging the very large gap between banks and equity investors.

Our terms are transparent and straightforward to understand. They get better the more you trade with us.

Any other options?

The only other option is conventional invoice finance – disclosed factoring is the most common product offered to small businesses. This typically involves onerous 12-18 month lock-ins, minimum monthly fees and hidden fees, especially on termination. Their best rates are only available to those that undertake to sell all of their invoices to the factor. And your customers will know all about it. This is usually not attractive to higher quality growth companies with large customers. For larger companies, there are confidential options but again you will need to lock into an exclusive, whole book arrangement with onerous termination provisions – this is usually more than you need most of the time and therefore overly costly.

The headline rates for conventional invoice finance can look attractive but the devil is in the detail. We do not operate that way – our fees are easy to understand and, based on experience, much better value than any other provider. And it’s truly confidential.

We realise that this can be confusing. Just call us and we will be very happy to have a relaxed, ‘non-pushy’ chat about why our customers love our product. If you’re still not sure, we are very happy to speak to your accountant or adviser as we are very transparent and keen to establish a trusted relationship. That’s why we do not lock-in our customers.

UK Perspective: The Many Shades of Alternative Finance

By David von Dadelszen on 20th November 2015

According to the FCA, 114 peer-to-peer companies have sought authorisation since it took over regulation of the sector, while 178 have interim permission to operate. The proliferation of market participants has seen newer entrants seeking niches in an attempt to distinguish themselves from the competition. Interestingly these differences have become very blurred, as has fundamentally what comprises an alternative finance company at all.

Mainstream finance

Since the foundation of the alternative finance sector, the recurring motif has been that the high street banks – Lloyds, Barclays, HSBC and Santander – are dinosaurs. Having formed the cornerstone of the retail and commercial finance industry for centuries, their relative stiffness was (and still is, although to a slightly lesser extent) an easy target for the marketing teams of the new, slicker and often cheaper alternative platforms. Most other market participants however, not just peer-to-peer lenders, will also lay some claim to being alternative (or ‘different’).

Peer-to-peer and alternative balance sheet lenders

Balance sheet lenders source borrowers in the same way as peer-to-peer platforms, but carry the credit risk themselves. ezbob and iwoca (who, incidentally, we recently transacted with) are two names that spring to mind. These businesses tend to be funded by fixed rate credit facilities agreed with investors in advance, putting capital onto their balance sheet which they can then lend-on at a higher rate, making a return from the spread. These businesses place a heavy reliance on technology to bring on and assess new businesses, reducing costs and delivery times.

Specialist lending funds

Specialist lending funds similarly invest in SME debt and, although transaction sizes tend to be larger, these funds are also balance sheet lenders. Investors put up the capital which the investment manager then lends; the commitments are just met predominantly with equity instead of debt (referring to unleveraged vehicles here, for the sake of argument).

Challenger banks

A number of challenger banks, including names such as Metro Bank and Aldermore, are aiming to loosen the stranglehold of the ‘Big 5’ banks and foster competition. They are also balance sheet lenders, paying a fixed or floating return to their investors, i.e. ‘depositors’, and again lend the funds on seeking to make a return from the spread. Now, the narrative is almost identical here between alternative balance sheet lenders and challenger banks: the core difference is the transaction size and the levels of customer service. The product set of the challengers is much wider than specialist AltFi lenders, but many alternative platforms are incorporating their tech-led approach into an ever-broadening service offering.

The big picture

The fragmentation of the finance industry is apparent, as is the lack of clear lines in the sand as to what really differentiates an alternative finance company from more traditional competitors. At the crux of it, the introduction of new technology to a stagnant retail and commercial finance sector (often by former big-bank talent) created a number of game-changing efficiencies. Now, competition is rife and all market participants, whether mainstream banks or peer-to-peer lending platforms, are jostling for position.

The assessment of the current lending market in the UK, that there are ‘the banks’ and there is ‘AltFi’, is far too simplistic. The real scenario is this: the credit market in the UK is diverse, deep, competitive, and incredibly fragmented.

David von Dadelszen

Director & Head of Operations, UK Bond Network


Fintech: Take the best and practice it

InvoiceX perspective: Good article. As experienced overseas fintech investors ourselves, we couldn't agree more with this comment: “Look at other people. Look deep at what is working and what is not overseas,” Harad said

Australian tech leaders explore steps to expand nation’s fintech boom

By  on December 02 2015 7:39 PM
Passers-by are reflected on a signboard displaying currency signs outside a bank in Tokyo November 27, 2014. The dollar edged down against the yen on Thursday after lacklustre U.S. economic data pushed Treasury yields lower and dulled investor appetite fo
Passers-by are reflected on a signboard displaying currency signs outside a bank in Tokyo November 27, 2014.

Fintech industry leaders stated that a lack of awareness on the pace of technological progress in overseas markets is hampering Australia’s full potential in the industry. As a step towards global awareness, an alliance of 30 leading players in the Australian fintech scene has put together a policy paper that outlines the steps that will put the nation at the top spot by 2017.

Moving toward the global scene

As reported by Startup Smart in November, a group of 30 fintech startups and founders, including MoneyPlace CEO Stuart Stoyan, Stone & Chalk CEO Alex Scandurra, and Fintech Melbourne founder Andrew Lai, signed a policy paper which compares Australia’s fintech landscape to the global leaders.

It discussed how some of the leading players, such as London and New York, worked to foster their fintech industries and where Australia is falling behind. The paper said that Australia’s fintech industry must be at par, at the very least, if not lead the way in some areas.

Scandurra pointed out that this is a crucial time for Australia’s fintech industry. “Disruption comes in waves so timing is everything.  The age of fintech started four years ago and if we act with focus and conviction at a political level we stand a good chance of becoming the top dogs of fintech in Asia,” he said.

With the aim of growing to be the most important player in the Asian-Australian region, Australian fintech leaders agree to zero in on some key areas of regulations and laws impacting the fintech scene: lending, wealth and insurance, equity crowdfunding, payments and data, and digital currencies and the blockchain. The paper calls out the key policy initiatives that Australia needs to put in place to ensure Australian fintech is globally relevant.

Take the best and practice it

Fintech expert Mitchel Harad, chief marketing officer of leading P2P lender SocietyOne, and payments disrupter Tyro CEO Jost Stollmann both believe that Australian start-ups need to be strategic about the talent they hire, and not just reinvent the wheel, as reported by the Sydney Morning Herald. They added that Aussie start-ups should place their minds ahead of the curve.

Harad said that local entrepreneurs should think globally and spend more time closely studying start-ups overseas and adopt their best practices. He added that his recent discussions with local start-ups aiming to create robo-advisers had displayed a shocking and disappointing lack of awareness about the developments in that market in the US. 

“Look at other people. Look deep at what is working and what is not overseas,” Harad said.

This sound advice has been practised by fintechs in established hubs abroad such as London, which has arguably the most successful fintech industry. Silver Falcon Plc (SILF:LN), a shell investment company that focuses on acquiring fintech companies, is one of the firms that took advantage of its local fintech industry. The company recently floated on the London Stock Exchange, opening at 3.5 pence a share.

“Presently these fintech companies are in need of more capital to take their businesses to the next level which is where we come in with our shell of 1.5m pounds in it and the ability to raise more money if necessary,” said Adrian Beeston, one of Silver Falcon’s directors.

In a recently concluded fintech summit, Stollman emphasised the need to think big, questioning if enough local start-ups have the passion to overthrow the traditional orthodoxy. He added that collaboration between start-ups and banks have been going around, which might remain an option for some start-ups. However, he added that more entrepreneurs should be prepared to put the gloves on and fight for ways to not only disintermediate banking profits around the edges but tackle them head-on.

“Today's banking solutions suck. They are full of friction, they are not a nice experience," he said bluntly. “The problem is you have to disrupt the banker client relationships and the customer franchise. That is extremely difficult."

While fintech start-ups are in need of support from the government in order to maximise Australia’s potential in the industry, there is also a need for the industry to work towards upping the ante. Through watching the start-ups in the global scene, and emulating the practices that catapulted these companies to success, Australia’s fintech potential will bloom into a full-fledge global hub.

Contact the writer at

Basel III, SME lending and the grave errors of risk weighting - insightful report by global accountancy group

ACCAReport by ACCA (the Association of Chartered Certified Accountants), the global body for professional accountants with over  140,000 members, 404,000 students and more than 8,000 Approved Employers in 170 countries - published in 2012 but worth re-reading as the report correctly foreshadowed the impact on SME finance worldwide

The focus of Basel III, and indeed of all capital regulation so far, is not primarily a bank’s balance sheet but the sum of its risk-weighted assets. Capital adequacy rules assign a risk weighting to each of a bank’s assets that is meant to be proportionate to the credit and market risk that the asset in question represents.

Under Basel III, loans to SMEs are assigned a relatively high risk weighting, inherited from Basel II, which should, when combined with rising capital requirements and turbulent capital markets, result in a disproportionately high cost of capital for banks when lending to such businesses and a gradual shift of their entire business models away from SME lending. Moreover, the evidence reviewed by ACCA (2011b) suggests that capital set aside against SME loans has, in the past, significantly exceeded any losses from defaults.

Basel’s approach to risk weighting is based on a significant misconception regarding the purpose of capital regulation. Risk weightings incorporate rough estimates of credit, market and operational risk (Blundell Wignall and Atkinson 2010). It is not, however, the purpose of capital regulation to protect individual banks from bad debt, poor investments or flawed internal controls. Financial institutions have substantial risk management functions and governance arrangements charged with this task and can generally monitor their exposure better and more regularly than regulators can. Regulators should, of course, review these functions and arrangements and will no doubt find much in need of improvement. But the purpose of capital regulation is to protect the wider financial system and the taxpayer from the banks’ flawed incentives.

Capital regulation, like all regulation, is only justified insofar as it addresses market failure. In the case of financial intermediaries it has been amply demonstrated by the financial crisis of 2008–9 that negative externalities do exist and that avoiding these does justify some kind of capital regulation. Through their actions, financial intermediaries expose their counterparties to systemic risk without bearing the social cost of this by-product of their activities. The result is an excessive accumulation of systemic risk, which is the proper province of capital regulation.

This distinction means that inferring ‘optimal’ risk weights from past or forecast default rates is a deeply flawed methodology because it conflates risks that should be the target of regulation with risks that should not. Both internal risk models (whereby the banks assign their own risk weightings according to internal risk calculations) and standardised risk coefficients (provided by Basel and the implementing regulators) are based on this principle and are thus equally problematic.

To illustrate: for a bank, giving a three-year €1m loan to an SME is doubtless much riskier than buying €1m worth of newly issued three-year AAA-rated government bonds. Statistically, some of the SME creditor population must default in a given year, while the AAA-rated sovereign is certain, for all intents and purposes, to survive and pay off its creditors. Hence a narrow view of risk will rightly consider the SME to warrant a much greater capital allocation. In fact, there is more to this story than this narrow view.

Unlike the SME loan, the bond can be posted as collateral many times over in the wider financial system (2.4 times on average, based on the estimated global velocity of collateral), enabling a disproportionate volume of transactions (Singh 2011). Its price will correlate strongly with those of a host of other assets to which the bank is exposed, and can be subject to unstable feedback loops involving these (BIS 2011); and because bonds are publicly traded, its value will change constantly and may do so at any instant.

To be fair, SME loans are not free from systemic influences (Direr 2002), particularly in sectors that rely heavily on trade credit. But the two assets’ systemic footprints (to borrow from the literature on another negative externality) hardly compare.

Put another way, nearly all the risk involved in an SME loan is borne by the lender as straightforward credit risk, and most of the rest is borne by the business owners as straightforward financial risk. In the case of the bond, however, the risks are more diverse and diffuse, and in buying, holding or trading the bond the bank has internalised only a tiny amount of these. This begs the question of how risk weightings can be corrected to reflect the kinds of risk that Basel should be targeting.

Given the sheer amount of political will invested in it, a wholesale review of Basel III is most unlikely, but a recalibration within the current framework may be possible. In fact, the Basel Committee has already demonstrated one approach to this in its search for ‘global systemically important financial institutions’ (BCBS 2011). That assessment set out to identify institutions that are Too Big or Too Interconnected To Fail through a set of criteria: cross-jurisdictional activity, size, substitutability and complexity.

A similar approach can be used to calibrate the existing risk weights, by asking the following questions.

• To what extent are assets traded between financial institutions, especially internationally?

• What share of the financial institution’s assets and revenues does the asset class represent?

• What share of total activity in the asset class does this institution represent?

• How complex is the asset in question?

This process could be used to derive systemic risk weights complementary to the credit, operational and market-risk weights already employed by Basel III. This would result in weights that are not only more conducive to SME lending but also more consistent with the purpose of capital regulation.