Sunday, 28 November 2010

Swiss Tailwind For Personal & Small Business Social Finance

Banks will find it more costly and less profitable to offer short term unsecured personal and small business finance under Basel III rules, according to a recent McKinsey report.

To comply with the new rules, Banks face a long review of their businesses and products to reduce risk, use capital more efficiently and minimise the need for market funding by the end of 2012.

Which is more great news for participants in the 'capital light' social finance business models, like Zopa and Funding Circle in the UK.

As I mentioned in the context of the proposals to regulate vertical shadow banking functions, people using these 'horizontal intermediaries' benefit from:
  1. Loan amounts being split into small one-to-one loans at inception, rather than having to wait for the slicing, re-packaging and grading involved in asset-backed securitisation;
  2. A direct, one-to-one legal relationship between borrower and lender for the life of the loan, enabling better control over debt adjustment and collection, where that becomes necesary;
  3. Lenders retaining day-to-day control of the management of their money and credit risk, minimising the capital required by the intemediary;
  4. The intermediary not needing to slice and re-package debt to alter loan maturities, since lenders can manage this by assigning loans of unwanted duration to other lenders;
  5. The intermediary having no balance sheet risk, and therefore no temptation to engage in expensive and complex regulatory, tax or other arbitrage;
  6. Transparency in the original underwriting decision and loan performance against grade - making lenders' due diligence easy, and removing the moral hazard of the kind we see in vertical intermediation models, where the endless slicing and re-packaging makes due diligence hard.
For these reasons, one might expect banks to allow their depositors to lend directly to their personal loan and small business customers. But it seems unlikely the banks could feed themselves on the scale of fees their nimble competitors can afford to charge. And they would soon face calls to allow the peer-to-peer approach for mortgages and larger corporate loans - by which time other nimble providers may well beat them to those segments too...

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