Avoid Britain’s big banks

In this week’s interview, I talk to Dr Pippa Malmgren, financial policy expert and former adviser to George W Bush.

She’s full of interesting thoughts on inflation and the velocity of money. But one thing we touched on that I would like to have spent more time on was the ongoing failure of our banking system to fulfil its usual purpose – lending money to individuals and companies.

In the UK, we hear endless complaints from smaller and medium-sized companies about how hard they find it to borrow money. Either they can’t get it at all, or they can’t get it at a price that makes any sense.

It is, I am told, entirely normal these days to be offered a loan, but be charged an arrangement fee of 8% of the value, regardless of how short-term the loan is.

It’s a strange situation we find ourselves in. Savers are awash with money they can’t get a return on. Yet borrowers happy to pay 6%, 7% or 8% can’t get their hands on the money without paying extortionate fees. The good news is that, as Malmgren says, “money is like water”. It always finds its way through the cracks in any system to the highest returns.

Today, it is doing that via a new shadow banking system made up of peer-to-peer (P2P) lenders, invoice financiers, crowdfunders and corporate lenders. This matters. It matters, because, as Malmgren suggests, it hints at a rising velocity of money (the first prerequisite for rising inflation).

But it also matters, because it’s deeply disruptive to the conventional financial industry. Right now, it may not seem like a threat – at the end of 2013, the UK’s online lending platforms hadn’t even lent out £1bn. In the US, they had yet to pass the $5bn mark. But that doesn’t mean they won’t.

Why? They have a cogent and constantly improving proposition (look out for the new offering from Nicola Horlick, Money & Co – it’s very impressive and consumer friendly). They are likely to remain relatively lightly regulated relative to banks – they don’t engage in fractional lending or create money, so don’t need heavy regulation.

Finally, they are likely to attract heavy institutional investment on the basis that they offer some pretty appealing characteristics – low volatility and low correlation to other assets, alongside an attractive yield.

Not convinced? Sloan Fellow Paul Jeffery says think back to the 1970s. Then, as now, institutional investors were desperate for a way to make real (after-inflation) yields. They found them in junk bonds: from 1977 to 1985 these went from being 3.7% of outstanding US corporate debt to 14.5%.

A move of that scale in the P2P and crowdfunding businesses (there’s no reason why there shouldn’t be one) would see the “windfilled sails” of the new platforms become a “Schumpeterian gale of destruction for the banks”. We haven’t been keen on shares in the UK’s big banks for a long time. We still aren’t.

Merryn

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