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The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

The Post-Bank Era



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Ashwin Parameswaran argues that one of the core justifications for what he calls the “modern maturity-transforming banking system” is falling away:

In our increasingly ageing and wealthy society, there is no shortage of capital available to fund new businesses. Household savings alone is sufficient to fund the required business investment.

We imagine that risky businesses can only be funded by the alchemy of modern maturity-transforming banking system. But as I showed in my last essay, the explosion of peer-to-peer financing in the United Kingdom today shows us that speculative equity ventures and business loans can and are being funded by the man on the street.

Although significant progress has been made recently, many of the hurdles to achieving a genuinely decentralised financial system are regulatory. By trying to protect small investors from the consequences of investing in a failed venture, we end up denying financing to small businesses. It is insane that we allow small investors to “gift” as much money as they want on Kickstarter but we limit them from investing in the same venture as a part-owner with the legal protections against fraud afforded by being an owner.

While equity crowdfunding has been covered as a niche phenomenon, Parameswaran believes that it is anything but:

Now you may argue – so what if we don’t need banks to conduct heroic maturity transformation that funds long-term investment? Surely we need maturity transformation to fund the more mundane activities that I described earlier – invoice financing, short-term business loans, mortgages etc. Until a couple of years ago, this question was literally unanswerable. The only honest answer would have been – who knows? But the explosion of activity in the peer-to-peer lending sector now enables us to arrive at some preliminary conclusions.

Intermediaries that facilitate peer-to-peer (P2P) lending are subject to very little regulation in the United Kingdom (unlike the process of starting a bank which can take years and land you with a seven-figure legal bill). Unsurprisingly, there has been an explosion in the number of peer-to-peer lending platforms in the UK. Conventional wisdom would suggest that individuals who lend through such platforms would lend their money at higher rates than banks would. After all, they have nowhere near as privileged a position as banks do – no ability to create money ex nihilo, no access to the central bank’s repo window. But the reality is exactly the opposite. The lending rates in the industry are, if anything, too low. Individual lenders are falling over themselves to lend money to risky individuals and companies at rates far lower than what banks would lend to them at (to take just one example, take a look at the borrowing rates at Zopa).

And P2P lending is not just a niche phenomenon – there are platforms that handle everything from invoice financing, bridge loans, longer-term loans to individuals and businesses and mortgages. The last couple of years have in effect given us a controlled experiment in what a non-maturity transforming lending system would look like. And the answer is that rates would be lower than they would be in a maturity-transforming system. Maturity-transforming banking is redundant – it only gives us recurrent financial crises. The idea that in the absence of bank maturity transformation, lending rates would explode has been disproven.

This still doesn’t give us any answers as to what we can do to stimulate genuine disruptive and risky investment that can drag us out of the ‘great stagnation’. The answer is simple – we need to do more to promote equity investment in disruptive new enterprises. The conventional wisdom states that there isn’t enough risk appetite for all the equity financing that new high-risk businesses require for their investment needs. Again, the growth in equity crowd-funding is slowly disproving this myth.

More broadly, Parameswaran maintains that the importance of banks as a source of long-term investment has declined in the most advanced economies, as bank lending is not a good way to finance the kind of firms that engage in risky product innovation; their role in invoice financing, short-term business loans, and mortgages can be taken on by peer-to-peer lending platforms; and that a low-cost “public deposit option” can provide all citizens with basic financial services. So the substantive case for traditional deposit insurance and bank bailouts is, in Parameswaran’s view, increasingly weak.

 



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