Ethical Funding: The Death of 'Fat' Banking

It's just cost Yell Group £80 million in fees to secure £660 million in funding. Apparently this is because there are over 300 lenders involved. So I guess you could say it cost about £284,000 per lender.

At the other end of the spectrum, over at Zopa, borrowers pay £118.50 to borrow directly from hundreds of people at the same time, with no bank in the middle.

Somewhere in there is the real cost of enabling people and businesses to obtain funding. And the longer the banks continue to insist on such enormous rewards for their role, the harder others will try to remove them from the process, or otherwise curb their perceived excesses.

Since steering Zopa through the maze of financial regulation, I've become aware of many others who are also implementing alternative funding strategies that take banks out of the process. It's complex and time-consuming, but less so now that starving advisers are starkly aware of their own need to provide a faster, more cost-effective service in this area. Recent figures reveal that Ireland and Luxembourg are reaping the rewards.

The fact that I can't really discuss these alternative funding sources without interfering with their marketing obligations underscores why the banks are able to charge such high fees.

Intensive regulation - ironically designed to protect the financial system and taxpayers from the kind of events we've seen occur regardless - has funneled the world's investment funds and opportunities into a cloistered environment in which only a privileged few are trusted to connect them. Enormous rewards for those few are simply a bi-product of that regulatory framework. It is unsurprising that those rewards should remain high as the flow of investment capital runs dry in the face of intensifying demand from cash-strapped banks and corporations.

So there is further irony in the European Commission's plans to regulate the alternative investment markets. This should simply concentrate the number of intermediaries who can arrange funding, allowing them to increase their fees, yet fail to deliver any incremental protection from the risk of financial failure.

The attack on 'excessive' fees and bonuses actually challenges the notion that matching investment capital and investment opportunities should be reserved for an anointed few. To remove the fat, you need to turn the situation on its head. The authorities should be fostering (not necessarily regulating) the growth of simplified, transparent marketplaces that are substantially open to all, linking investors and issuers of stocks and bonds in a direct sense, albeit still facilitated by skilled, lean operators.

Such a process of simplification, with increased openness and transparency, is entirely consistent with the rise of directly accessible consumer marketplaces for consumer goods, travel, betting, entertainment, personal finance and trade finance during the past decade. In those marketplaces, the role of the facilitator has been to enable consumers to seize control of their own experience and keep much more of the value that was previously retained by 'traditional' product providers.

In this sense, the "democratisation" of the financial markets may be seen as very much a logical step, rather than anything terribly radical. It will be important to get the rules right - just as that has been critical to the success of many other consumer platforms already out there. But openness, fairness, transparency, and both governments' and taxpayers' determination to get out of this mess, ought to be reliable guides.

Big Media Must Make Itself Useful

Rupert Murdoch thinks search engines are getting a 'free ride' on News Corp's content. He also sees little value in 'occasional' visitors who are attracted by a headline they see on a search engine and click through. He says so much content is freely available online because the traditional media 'have been asleep'. Clearly, he wants people to use - and pay for - each of News Corp's media properties as an activity in itself, as in "I want to read the Sun," or "I'm going to watch Fox News now" rather than as an adjunct to their every day activities. To achieve this, he proposes withholding content from the search engines.

He's not alone. Lots of newspapers seem to be planning to reintroduce subscription services online, and there's plenty of discussion about what content might attract a premium.

Of course, many businesses look at the world through their own products, rather than what people are actually doing, or would like to do. Banks, for example, offer 'personal loans' and 'mortgages' quite independently of the use of the processes involved in actually using the money they lend. As a result, people have come to see their bank as just a very basic utility, rather than an integrated part of their lives. 'News' already seems to have gone the same way.

What the media and the banks of this world don't seem to 'get' is why search engines have become so central to people's behaviour.

People don't 'read' search engines. They don't even spend much time there, compared to their destination sites. So why do search engines dominate the advertising world? Because they are key enablers or facilitators of what people are actually doing or want to do. Even if some links are sponsored, a search engine doesn't try to determine what you see or do. Unlike the 'traditional media' or banks. A search engine enables you to efficiently answer the vast number of often quite mundane questions that confront you every day - 'Where are their offices?' 'How do I get there?' 'Can I get this cheaper anywhere else?' 'How many goals has Blogs scored this season?' 'Why are Australian animals so weird?'

No matter how much different content any one provider offers, it will never answer all of everyone's critical questions. And the more it tries to corral people and dictate what they see, the less they'll trust it to give them the information they want.

So the challenge for traditional media is not whether or not they charge for their content. Instead, opportunity lies in becoming more integrated with people's actual or desired every day activities. The more integrated the media are, the greater share of the consumer value chain they might command.

Flight of Funds, FSA Registrations Down

When I asked Vince Cable recently what he thought of the alleged flight of hedge funds from the UK in fear of EU regulation, he said he wasn't aware of any such flight, but it would be "irrational". First, he said, the UK has not - and should not - pander to those in search of a tax haven. Second, he thought it likely the UK will be successful in removing certain protectionist elements from the EC's plans to regulate the alternative investment sector.

I thought this sounded very thin at the time. But I also thought it interesting that Vince went out of his way to mention the tax point.

So no surprise, then, that Lord Myners has just 'spoken in favour' of tax-effective regime for alternative investments on the back of a recent report "that £300bn of UK-managed funds have gravitated to Luxembourg and Ireland, at a cost to the UK of about £300m a year in lost revenues."

The fact that funds choose to remain in the EU suggests the regulatory fears are overdone. Either managers are resigned to regulation, or bullish about watering down the EC proposals.

It's also worth noting FT reports that "only 247 new banks, brokers and insurance firms sought authorisation from the Financial Services Authority in the three months to September 30, while 643 firms cancelled their registration, according to data compiled by IMAS Corporate Advisors."

Do Price Comparison Sites Increase Premiums?

Hypothesis: the rising cost of car insurance is actually driven by marketing costs.

Gross premiums have increased 14% in the past year, and the car insurance industry would have us believe this is driven by the 'rising cost of personal injury claims and fraud'. But that would suggest net premiums (the proportion of the gross premium that actually covers the insured event) are being priced wrongly, which I find difficult to believe. Actuaries must be fairly good at predicting accident rates, deaths and injuries and so on by now. And these actually appear to be in decline, according to the Office of National Statistics research published in April 2009:

"The total number of deaths in road accidents fell by 7 per cent to 2,946 in 2007 from 3,172 in 2006. However, the number of fatalities has remained fairly constant over the last ten years...

The total number of road casualties of all severities fell by 4 per cent between 2006 and 2007 to approximately 248,000 in Great Britain. This compares with an annual average of approximately 320,000 for the years 1994-98.

The decline in the casualty rate, which takes into account the volume of traffic on the roads, has been much steeper. In 1967 there were 199 casualties per 100 million vehicle kilometres. By 2007 this had declined to 48 per 100 million vehicle kilometres."

So I wonder if there's a variable cost in there that's proving difficult to control. A chief culprit might be marketing. We're certainly being inundated with TV advertisements for insurance price comparison sites, so I wonder if that is in turn being paid for by higher 'costs per click' associated with advertising on those sites? While some insurers are refusing to list their products on the price comparison sites, they may still face competition for key search terms, for example.

Needless to say, I haven't yet been able to find much public analysis on this, but there is a helpful post on analysing the efficiency of cost per click by The Catalsyst. It's easy to over-spend, and the competition may force you to.

If my hypothesis is right, the case is building for semantic web applications to enable people's computers to find deals simply by interrogating insurers' computers - without all the expensive advertising noise.

Extra Data From Us is Key To Financial Health

Just for fun, I've been wading through the FSA's discussion paper on reforming the mortgage market.

The FSA's aims are to ensure the mortgage market is sustainable for all participants, and works better for consumers - and taxpayers.

The credit crunch has shown that consumer lending and related securitisation programmes have become a high risk, low/no data process. That has to change.

So, the immediate challenge to the FSA's approach is the decision (thinly explained on page 67) to focus only on the 'mortgage market', rather than the role of mortgages in the 'credit market' or indeed the overall investment market of which the credit market is an integral part. Of course, the FSA's remit and resources don't even extend to unsecured credit, let alone the entire investment market. This silo mentality renders the investment markets a fool's paradise.

Secondly, lenders and their investors (including the Treasury) will only get better at risk management if all the data systems in the lending/investment process are up to the job of collecting and processing enough credit data. That includes using the data gleaned in the underwriting process to help inform the loan collections/enforcement process, then 'closing the loop' by feeding the lessons learned back into the underwriting and investment processes. It would be interesting to see how much work the FSA has done to understand and encourage the level of investment in systems used for underwriting, collections and investment decisions.

Thirdly, the FSA is right to avoid 'blunt' caps on loan-to-value and debt-to-income ratios. Adding a more detailed calculation of 'free disposable income' is a good way to introduce more data that might help lenders and investors predict the likelihood of default. But that will only work if borrowers are willing to contribute accurate data, rather than try to 'game' the system - which lenders/investors will end up tolerating. So far, the FSA seems to be generating consumer resistance to providing extra information to lenders (making it harder for lenders to ask) by not explaining that extra data is critical to lenders improving their credit risk management systems, which ultimately protects the entire financial system.

The discussion period ends on 30 January 2010.