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Saturday, 9 June 2012

Why The Banks Have Not Been Googled... Yet

In March this year, Andy Haldane, Executive Director of Financial Stability at the Bank of England rather helpfully gave a speech in which he likened peer-to-peer finance platforms to the likes of Google and eBay. But the basis he gave for his comparison overlooked a fundamental difference in the UK's retail markets for financial services compared to those for online search and second-hand sales. Funnily enough, that difference lies in the regulatory and tax framework for which both the Treasury, and to a large extent the Bank of England, are responsible.

Specifically, Andy Haldane said (at pages 14 and 15):
...birth and death rates in banking are lower than among non-financial companies. They are lower even than in other areas of finance. Death rates among US banks have averaged around 0.2% per year over the past 70 years. Among hedge funds, average annual rates of attrition have been closer to 7% per year. Birth rates are similarly low. Remarkably, up until 2010 no new major bank had been set up in the UK for a century...
Commercial peer-to-peer lending, using the web as a conduit, is an emerging business. For example, in the UK companies such as Zopa, Funding Circle and Crowdcube are developing this model. At present, these companies are tiny. But so, a decade and a half ago, was Google. If eBay can solve the lemons problem in the second-hand sales market, it can be done in the market for loans.
With open access to borrower information, held centrally and virtually, there is no reason why end-savers and end-investors cannot connect directly. The banking middle men may in time become the surplus links in the chain. Where music and publishing have led, finance could follow. An information web, linked by a common language, makes that disintermediated model of finance a more realistic possibility.
While it is helpful to find some official recognition of both the lack of innovation and the paucity and size of new entrants to the banking market, the root cause of this scenario does not lie in the lack of a common language or information web (though I've been longing for a semantic solution to price comparison sites for years now).

A clue to the limitations of Andy Haldane's hypothesis lies in his measure of Google's success - its stock market valuation - when a far better measure for current purposes is the scale of Google's advertising revenue. In 2001, Google's total ad revenues were about $67m. By the end of 2011, those revenues had risen to $36.5bn, up 29% on the previous year, and represented 96% of the big G's total revenue.


How did this happen? Well a clue lies in the fact that Google has 75% of search advertising spend. Google's search feature is second to none and is clearly a far better knowledge filter than the traditional media.

So let's assume, for argument's sake, that Andy is right to suggest that Zopa's platform offers the same kind of utility, convenience and empowerment to savers and borrowers as Google's search function offers to the average internet user. When Google was 7 years old, in 2005, it's ad revenues were about £6bn. Seven years after its launch, Zopa has enabled £200m in loans, and is still growing rapidly, yet this represents about 2% of the UK personal loan market, according to the company.

Is something else at play that would explain the small number of new entrants and their slower rates of growth in the markets dominated by banks?

As previously point out, the critical difference is surely that there is no regulatory regime presenting traditional newspapers as officially sanctioned and somehow 'safe'. No tax incentives to persuade consumers that its better for them in the long term to buy a newspaper instead of searching for stories online. No compensation scheme exclusively for advertisers who don't get what they expect from their newspaper advertising spend, leaving Google advertisers to fend for themselves. No taxpayer guarantee that allows newspapers to spend whatever it takes to maintain market share.

Banks, on the other hand, rejoice in all that protection, even though we know they are failing to fulfill their fundamental obligation to move money efficiently from those who have it to the people and businesses who deserve to use it.

Some of the peer-to-peer platforms have formed the Peer-to-Peer Finance Association and campaigned for a level playing field, so far to no avail. But given all the official protection from innovation and competition, it is unrealistic to assume that new financial platforms will thrive as they should without some alteration to the regulatory and tax framework to enable more rapid market entry and strong, responsible growth.

Image from Silverback.

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