Wednesday, 31 October 2012

Kickstarter's Kick In The Butt For UK Banks

The news that Kickstarter, a US rewards-based crowdfunding operator, has opened a dedicated UK platform is hugely encouraging for anyone concerned about our banking problems.

No doubt Kickstarter is responding to demand from the UK-based entrepreneurs and their supporters who were already using the US platform. But it's also a big bet on the future of alternative finance in the UK, and Kickstarter's expansion will mean a lot of focus on the different ways that people can directly fund other people's personal finances, projects and businesses.

The term 'crowdfunding' first gained currency to describe US 'rewards-based' peer-to-peer platforms like ArtistShare and Kickstarter, and similar platforms already operate in the UK (e.g., Crowdfunder and those mentioned here). These platforms are designed to raise money for small budget projects via the internet without infringing laws that control the offer of 'securities' to the public. Entrepreneurs can post 'pitches' seeking donations, and may offer a 'reward' of some kind in return.

Other peer-to-peer finance platforms enable markets for personal loans and small business loans - called 'person-to-person lending' or 'peer-to-peer lending'. Examples include Zopa, Ratesetter and Funding Circle in the UK, Comunitae in Spain and IsePankur in Estonia which just announced that anyone from the EEA and Switzerland can lend to Estonian borrowers.

The peer-to-peer model has also been adapted to fund charities or not-for-profit projects, which is known as 'social finance' (e.g. Buzzbnk); and to enable many people to fund tiny local businesses in developing countries - referred to as 'micro-finance' (e.g. Kiva, MyC4).

Finally, the peer-to-peer model is being developed to enable direct investments in return for shares and more complex loan arrangements (debentures). This has proved impossible to date in the US, where even Lending Club and Prosper have had to register their peer-to-peer lending platforms with the Securities Exchange Commission. But in the UK, Crowdcube and, more recently, Seedrs and BankToTheFuture appear to have found ways through the regulatory maze to enable the crowd to invest in the shares of start-up companies. Abundance Generation enables funding for alternative energy. Kantox enables people to switch foreign currency and Platform Black enables the sale of trade invoices. CrowdBnk, Trillion Fund and CrowdMission say they're coming soon.

There are signs that the regulatory maze will become much easier to navigate. Both the US and UK governments have recognised that more needs to be done to encourage the growth of these alternative forms of finance. 

The US passed the JOBS Act to provide ways to enable crowd investment in securities. And against a backdrop of proposed legislative changes in the UK, the government has praised self-regulation by the industry and set up a working group to assess the need for changes to the legal framework. That working group includes representatives from the Office of Fair Trading, the Department of Business Innovation and Skills, HM Treasury, the Financial Services Authority and the Cabinet Office. The Department for Culture Media and Sport is also interested in the potential for peer-to-peer finance to fund the development of arts and entertainment. 

The European Commission is also taking an interest in this field, and a regulatory summit is being planned in early December to introduce industry leaders and EU/UK policy-makers and regulatory officials to discuss proportionate regulation to encourage the responsible growth of peer-to-peer finance.

Kickstarter has made a pretty solid bet.

Tuesday, 30 October 2012

Roundheads v Cavaliers

Dog eat dog
Last night I found myself in front of "Roundhead or Cavalier: Which One Are You?", a sort of 'Dummies Guide' to the English Civil War which, needless to say, I found quite informative.

Perhaps the key difference between the Roundheads (puritan Parliamentarians) and Cavalier (flambuoyant Royalists) was the Roundhead preference for rigorous discipline over their opponents' dedication to partying and lining their own pockets. Tellingly, the ripely named Prince Rupert of the Rhine (of hunting poodle fame) was unable to prevent his Cavalier cavalry from looting the Parliamentarian baggage while the battle raged. This wasn't so much of a problem early on, at the Battle of Edgehill, but had tragic consequences at the Battle of Naseby which spelled the end for the Royalist cause. 

In the show's closing stages, we were treated to various pundits views on whether modern Britons are more Roundhead or Cavalier in their attitude. And while the comparison wasn't made, it occurred to me that recent events have revealed a certain preoccupation with looting in the heat of battle, resulting in the rolling of heads... 

But beware the Restoration.


Thursday, 11 October 2012

Banks Tell Customers Last

Bailing out (of) the UK
Two days ago it was all over the national media that ING Direct UK's savings and mortgage business had been sold to Barclays, with the actual transfer to occur in Q2 2013. Yesterday, the media were telling us what it means for customers. Yet only this morning do I receive the self-centred email from ING Direct UK (extract below). I'm not suggesting that we customers should get the information ahead of the stock market (if it's price sensitive). But I think we should've been among the first to know directly, rather than being told by the national media. 

Of course, the note also reveals that the bank views its customers as just a bunch of financial assets, and that the deal is a huge blow to competition and innovation in the retail banking market. The first three paragraphs blather on about the wisdom of ING slimming down and how the business "is a good fit" with Barclays millions of other customers. This makes us feel so special. Then, as an afterthought, they add the weazily statement that "there will be no immediate effect on the services you currently receive." Weazle word: "immediate". As in, "get your money out immediately." If I'd wanted to save with Barclays, I'd have followed the 15 million other sheep long ago. My old Egg credit card got bought by Barclays and that experience hasn't been warmly personal either. Time to switch.

"We wanted to let you know directly that it has been announced that ING Direct N.V has entered into an agreement with Barclays to acquire ING Direct UK’s savings and mortgage business.

This decision is a result of ING Group’s continued evaluation of its portfolio of businesses, in line with its stated objectives of sharpening its focus and streamlining the group. It is expected that the actual transfer of ING Direct UK’s savings and mortgage business will take place during the second quarter of 2013.

ING Direct UK is a good fit with Barclays existing UK Retail Banking Business that looks after more than 15 million personal and 700,000 business customers in the UK. With a network of around 1600 branches in the UK, customers can bank in person, over the phone, online and through mobile applications. Barclays look forward to continuing to provide a secure home for your savings and/or mortgage in the future.

There will be no immediate effect on the services you currently receive."

Monday, 8 October 2012

Google, Amazon and The Shape of SME Finance

In November 2007 it seemed clear that facilitators like Google and Amazon would capitalise on their alignment with their customers' day-to-day activities to disrupt banking. Both of these giants already have e-money licences in Europe (I helped Amazon apply for its own), and the latest foray is into trade finance. Google will offer a line of credit for AdWords advertising spend, while it appears Amazon will lend to selected small businesses against their projected sales over the Christmas season. 

While these services may be offered initially in the US, where there are lots of small business funding options, bear in mind that only four UK banks control 90% of the small business finance market and are lending less and less to them. And while some UK banks enable some merchants to obtain cash advances against their card receivables, it's not exactly a core activity.

The competition alone must prove welcome, yet the critical feature of both the Google and Amazon services is that they are seamlessly intertwined with customer behaviour. Both businesses could have decided to launch free-standing, me-too banking services (like the UK supermarkets), but they have not done so. No doubt they also intend to attract new customers with the latest services, but only by showing that they support what small businesses want to do - namely, sell their own goods and services across a staggering array of markets and demographies.

And by patiently facilitating their customer's activities, neither Google nor Amazon needs to incentivise staff to sell services to people who don't need them, as banks have done.

Friday, 5 October 2012

Nude Labour and The Hung Parliament

Hung Parliament
Three Labour Party conferences after the sun set on New Labour, and it must be obvious to everyone that the party's eon in power gave it no insight at all into what might fix the root causes of this country's economic and social problems. So I must henceforth refer to the latest evolution as "Nude Labour".

Not that I'm any great fan of the other parties. As I said in May 2010, a hung Parliament means we have MPs where we want them: "They are not in control. They have little alternative but to listen and respond to our issues bottom-up."

I said "little alternative" because they are very persistent in manufacturing policies designed merely to get themselves elected rather than to actually solve the country's problems. This manufacturing process seems to consist of endless polls amongst 'swinging' voters (the confused but willing) and 'deserters' from the last election, littered with leading questions designed to persuade the victims that the party has the answer to problems created to fit pet policies. At the same time the 'party leadership' must battle the zealots and extremists to avoid appearing like complete lunatics to the rest of us. Oh, and of course they must find ways to disagree with everything the other parties say. And blame other politicians for every error, to encourage the myth that politicians make a difference. 

The recent West Coast railway fiasco is a case in point. The opposition politicians seem obsessed with blaming other politicians, rather than focusing on the deep problems in the way government departments have handled such bidding processes for many years. For instance, Daniel Kahneman refers to a "Planning Fallacy" in his book Thinking, Fast and Slow. He points to a 2005 study of worldwide rail projects between 1969 and 1998, in which it was found that 90% over-estimated passenger numbers by an average of 106%, and costs overran by an average of 45%, regardless of the publicity associated with each debacle. Gee, I wonder if it's possible that government tendering processes somehow reward bidders who over-estimate utility, and under-estimate cost?

It would be glorifying political parties to say they are themselves a root cause of problems in the UK. As I said in the context of the Red Book, their internal activities are more or less irrelevant to how any problems actually get solved by the more pragmatic amongst us. Witness the Labour Left's dogmatic approach to the reform of the NHS or social housing. And Ed Ball's astonishing rabbit-out-of-a-hat idea to blow the revenue from a 4G licence licence auction on affordable homes merely served to distract conference delegates from Labour's terrible record on actually building them. For the rest of us, his proposed magic trick eerily echoed Gordon Brown's ultimate destruction of the enormous 3G windfall. Hey, let's never forget that Balls was an economic adviser to Brown and staunch ally to the bitter end, and Ed Milliband was Brown's special advisor from 1997 to 2002. None of those people must ever be allowed anywhere  near the nation's coffers ever again.

Alas, not content with showering us with raw waste from two political non-events so far, we must now endure big media's coverage of the Conservative Party's attempt to thrill the faithful with its own recipe for clinging to power. A poor lens through which to view the world, but good fodder for the writers of vitriol. 

Meanwhile, it's down to each of us to find real solutions to the root causes of real problems, charting a pragmatic path through the party-political dogma-doo-doo.

Tuesday, 2 October 2012

Careful What You Incentivise

Two things seem to be choking the flow of money to people and small businesses in the UK: broken regulation and perverse incentives. Yet there's a tendency to focus more on regulation, and to only see the obvious incentives - like bankers bonuses. Some innovative self-regulation in retail finance has been welcomed by the UK government, and banking reform creeps ahead. But all this could prove futile if problems with incentives are not also addressed. To fix those, we need to look below the surface at the more fundamental incentives at play in the financial system. In particular, we need to understand the extent to which the likes of ISA schemes and pension investment rules are limiting competition and innovation in financial services and inhibiting economic growth. I've summarised some recent debate on this below, and added some comments on the government's latest defence of the ISA scheme. I'd welcome your thoughts.

Some of the perverse incentives have been outlined to government by tax colleagues previously (in Annex 3 to this document). In essence, the contention has been that certain tax relief selectively favours banks and the suppliers of regulated investments to the detriment of innovation and competition. In particular, the tax free ISA system funnels ordinary people's savings into UK bank deposits on a vast scale, which the banks then fail to lend. This effectively discourages and inhibits those same people from diversifying, one alternative being to extend finance directly to other creditworthy people and businesses through peer-to-peer platforms. As a result, it's been suggested that the ISA system should be extended to cover such direct finance. Indeed, in his response to the Red Tape Challenge, Mark Littlewood, Director-General of the Institute of Economic Affairs and a 'Sector Champion' said:
" is surely worth noting that the present format and definition of the ISA wrap may have raised “barrier to entry” problems for new financial products and it may be beneficial to review these to stimulate innovation in the sector."
But the impact on innovation is merely the tip of the iceberg. It's the impact on the wider economy that must be understood.

There is overwhelming evidence that the UK's small businesses are cash-starved. They represent 99.9% of all UK enterprises and are responsible for 60% of private sector employment. Their output is critical to the UK's economic growth, which has stalled. Yet they face a funding gap of £26bn - £52bn over the next 5 years. Critically, the four banks which control 90% of the small business finance market are lending less and less to them. This is a red flag. You might think from their enormous market share that these banks would consider small business lending to be very important and a retreat from that market unwise. But, as the economist Richard Werner has pointed out, the reality is that only about 10% of the overall credit issued by our banks goes to productive firms. The other 90% goes to fund deals involving financial assets which don't count towards economic growth figures. So for these banks small business lending is actually a sideshow. They clearly make their money elsewhere.

Yet the ISA scheme had lured savings and investments of £391bn from UK adults by the April 2012, half of which is in cash deposits in these same banks. And they pay nothing for it - a paltry 0.41% in interest after 'teaser rates' expire, according to a 'super complaint' by Consumer Focus in 2010. 

In other words, the government appears to be incentivising workers to plough their savings into banks which virtually ignore the sector on which most of those same workers depend for their income. 

Contrast this with the position in Germany, where 70% of the banking sector comprises hundreds of small, locally-controlled banks who provide 40% of all loans to SMEs.  In an ironic twist, the UK government now sees peer-to-peer platforms as a similar conduit for a new German-style government-directed lending programme. But it appears never to have openly considered that the limited scope of the ISA scheme is part of the problem. 

In March, the goverment defended the narrow scope of the ISA scheme for the reasons extracted here. In September, the government gave a different response (see p. 13 here). In the hope of sparking wider debate on the issues, I've set out the current defence of the status quo below (my additions/comments in square brackets). I welcome any comments.
"HM Treasury believes that there is not a strong enough case for [making bad debt relief available to P2P lenders], as creating an exception would add complexity to the tax system and is difficult to justify when other [unspecified] forms of investment do not qualify for bad debt relief. Moreover, the current tax treatment of P2P investors is not necessarily a barrier to further expansion, as witnessed by the impressive growth in the industry in recent years.
...HM Treasury does not believe that P2P loans are suitable for inclusion in ISAs. The risk profile of P2P lending is too high [compared to what? cash ISAs? stocks and shares ISAs?], and it is unlikely that the platform can satisfy some of the [unspecified] features essential to the operation of ISAs.
Consumers tend to view ISAs as a relatively safe and simple investment vehicle [this fails to distinguish between cash ISAs and stocks/shares ISAs. And are they safe?]. ISA investments are thought of as relatively low-risk, and consumers should be able to get access to their funds whenever they wish. This is less likely to be the case with P2P lending than with existing ISA Qualifying Investments [this could be cured by permitting secondary markets in P2P loans]. 
Similarly, existing Regulations require ISAs to be operated through an ISA Manager [regulations could include P2P platforms], who invests through persons or firms who are authorised by the FSA, and thus have access to the FSCS [this does not mean you can't lose the principal in your stocks/shares ISAs, or stop banks paying 0.41% interest on cash ISAs]. As far as we are aware, current P2P lending platforms are not conducive to the ISA Manager role, are not regulated by the FSA, and do not offer Financial Services Compensation Scheme (FSCS) protection [any or all of which could be changed by regulation].
Finally, in order to be included in an ISA, P2P loans will require to be listed as a Qualifying Investment. Qualifying Investments are identified generically. It would be extremely difficult to restrict a generic description such as “loan” only to loans made via P2P lending platforms [but none of the qualifying investments are so generic, being limited by reference to 'banks', 'building societies', 'recognised stock exchanges' etc., so why not by reference to 'P2P platforms'?]. Exclusion from the ISA wrapper does not make this type of lending exceptional; rather, it puts it on the same footing as investment in stocks and shares issued by unlisted companies [how are these activities equivalent?]."
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