Informed Funding |
The AFN event last week looking at how alternative and conventional finance are starting to work together turned up a lot of interesting views from our panel of six expert practitioners. This is a subject we’ll definitely be returning to, but reflecting on the discussion a few top-level themes stood out for me.
It’s clear that there are numerous potential ways for the two camps to collaborate, but by far the most developed so far is for institutions to provide capital for alternative finance platforms to lend. Or to put it another (and perhaps more relevant) way, for alternative finance platforms to act as deal originators for institutions that have capital to deploy and to provide credit analysis for institutional lenders that may not have an in-house credit function themselves. It’s no surprise that this model has taken off: we are in a market where risk-free returns are extremely low and there are huge amounts of cash available. Everyone therefore has a strong incentive to search more widely for sources of yield. P2P answers this demand increasingly well and I would expect this model of collaboration to prove sustainable. Note, for example, Landbay’s very large warehouse credit line secured this summer to fund buy-to-let mortgages.
That said, there is no doubt that it is going to work strongly in favour of the biggest P2P platforms because they will have the largest bodies of data on existing and previous borrowers, the greatest ability to invest in technology to support their lending activities and the best opportunities to diversify exposure. In this sense, collaboration between institutional and alternative finance is going to widen the gap between the leaders in alternative finance and the rest.
This type of collaboration is different from some of the other models that could develop, mainly because the institutions providing most of the capital to lend via P2P platforms are not themselves direct lenders to consumers or small businesses and don’t therefore compete with P2P platforms. Other finance providers, obviously including banks, do compete in the same markets and collaboration here has consequently been much slower to emerge.
What sorts of collaboration might be feasible? You might, for example, imagine a world in which alternative platforms, both debt and equity focused, financed businesses that were too small or too risky for a mainstream bank to serve, but that as these businesses grew and became less risky they would graduate to a fuller banking relationship. Equally, you might imagine a world in which organisations that approached a bank but did not fit its criteria would be referred on to a range of alternative providers better suited to meet its needs. You could think of this as the “feeder/referral” model, in which business passes back and forth across the alternative/conventional divide according to the risk appetites of each side.
As I say, you might imagine that and for the moment you would have to, since there is still not much evidence that it is actually happening. The government’s efforts to establish a referral system from banks to alternative providers is meant to bring this into being, but it is taking a long while to do so and carries a major risk of “adverse selection”, which in everyday language means that the only business that would be referred would be business that probably shouldn’t be written at any price. Mandatory referral is not the same as partnership and anyone who sees it as a substitute for a properly negotiated commercial relationship is kidding themselves.
But there are other possibilities, for example that of Fidor Bank, a technology-driven bank from Germany that has recently won permission to operate in the UK. As Jonathan Segal of Fox Williams pointed out at our seminar, Fidor operates a technology platform and provides basic banking services to its customers such as current accounts and payments. But it also enables other finance providers to plug into its platform and offer their products alongside its own. For P2P players that tend to specialise in a single product, this could prove a very interesting model and provide access to several advantage, including a flow of potential customers and a partner that has a banking licence and access to deposit insurance.
It is very early days and there will doubtless be dead-ends, but we have not yet exhausted the ways in which alternative finance platforms could work with their mainstream counterparts.