STAFF NEWS & ANALYSIS
Approaching Asteroid Threatens Banks
By Philippe Gastonne - August 24, 2015

We are becoming used to doing more of our banking online or on mobiles – in fact it has probably been some time since many of us actually set foot in a high street bank branch. This might lead you to conclude that the internet has shaken up or disrupted the banking sector.

But actually banking hasn't even begun to be disrupted in the same way that the likes of Expedia, Betfair and Amazon have transformed the face of high street travel, betting and book-selling respectively.

That is changing with the growth of peer-to-peer or market-place lending platforms which connect borrowers and savers.

The combination of these disruptive waves should have banks worried and I believe they are. – The Telegraph, Aug. 22, 2015

In a world where economic dinosaurs quickly go extinct, traditional banking is one of the prime survivors. Abundant capital and friendly capital have let it adapt to every challenge.

When banks lost commercial lending business to asset backed securitization in the 1980s, U.S. bankers convinced politicians to knock down the Glass-Steagall wall so they could enter the trading arena. When their risky trades blew up in 2008, the Federal Reserve came to their rescue with unlimited free capital. Instead of shrinking, banks grew bigger and bolder.

Now the behemoth banks face a new existential threat. "Peer-to-peer" online lending platforms are still only a tiny fly buzzing around the banking brontosaurus, but disintermediation always begins small. Today's economy ruthlessly destroys any intermediary who doesn't add significant value – and the core of banking is to connect lenders and borrowers.

Now that the Internet connects everyone to everyone else, those who wish to borrow and those who wish to lend no longer need banks in the middle. Peer-to-peer lending platforms make introductions and process the necessary contracts far more efficiently than banks.

This revolution, if nothing stops it, could bring massive economic change. Peer-to-peer loans are unleveraged. They don't create liquidity from thin air like fractional reserve banking. A world of unleveraged lending would be a world without credit-driven booms and busts.

Combine peer-to-peer lending with bitcoin's blockchain to store value and facilitate transactions, and we may be within striking distance of a true economic revolution. Banks will not like it, either.

Bankers see the threat. JPMorgan Chase CEO Jamie Dimon warned earlier this year, "There are hundreds of startups with a lot of brains and money working on various alternatives to traditional banking. They are very good at reducing the 'pain points' in that they can make loans in minutes, which might take banks weeks. We are going to work hard to make our services as seamless and competitive as theirs."

This is a remarkable admission by Dimon. He knows his species of banker is inferior. He thinks hard work will let JPMorgan Chase stay competitive. We should wish him well, but the traits he needs to survive are not in his bank's DNA.

This being the case, the only way traditional banks can survive is with political protection, and that can't last forever. Consumers will ultimately decide.

Maybe, as a last gasp, the government can establish a financial endangered species refuge. Think of it as Yellowstone for bankers. They can graze there peacefully and remind us of a world gone by.

Posted in STAFF NEWS & ANALYSIS
  • Jim Johnson

    I long ago advised young people to not seek a career in their passion for building. While home prices doubled, then doubled again, then doubled again, the pay to build them remained static, if not lower. Who made the money, if not those actually building? They did not even get a tiny cut of the increases. So yes, I am glad to hear that a connection is being made between costs and those creating real value.

    • Frederic Freeload

      When you look a real estate across the country you see there is no consistency in valuation .

      • Injun Holbrook

        There shouldn’t be any consistency in valuation anyway. Each real estate sector and region is individually evaluated. The only consistency if any would be interest rates.

        • Frederic Freeload

          Consistency in valuation is based on home ownership … not market pressures driven by borrowed money … people that borrow money to buy a home do not own it until the loan is paid off…Supply and demand is allowed to drive the market as long as there is money to borrow… guess what …that is about to dry up again…. Home valuation should return to 1998 – 2000 valuation and stay there instead of feeding the greed of brokers who have no skin in the game and bankers who are counting on a tax payer bailout for their bad loans..An entire generation are being denied home ownership because of this GREED…

          • Diocletian

            People are denied true home ownership because of coercive property taxes, which gives government control, therefore factual ownership of all real estate, the land the improvements thereon, and the resources beneath its surface. Of course, the government’s central banking system is in league with this arrangement. True home ownership is expressed by allodial property rights which enable one to have full, absolute dominion over all aspects of one’s residential and commercial property, incapable of being usurped by government by a property tax. What people actually have is merely de jure occupancy of real (the Spanish word for “royal) property, represented by the certificate of legal occupancy, i.e. the title deed, that they purchase by means of a mortgage. Refuse to pay property taxes, and in addition to liens that the government’s bank or other lending entity will impose upon your certificate of occupancy, the government will eventually deploy its armed goons to forcibly evict you from “your” home, and murder you if you resist eviction.

            Such is the reality of the American Dream of home “ownership”. Unjustly, it is merely a dream, thanks to coercive property taxes and eminent domain.

    • dave jr

      But after the storm blows over, we’ll praise the youngsters who learned how to build…learned other uses for their thumbs, other than game console control. Why would you advise anyone against their passion? Why teach them faux lessons which only bolsters a faux monetary economy of intel/master/bank/approved gain/loss? Rather, advise them of the real economic basics. Amazingly, the kids are not dumb.

  • Bruce C.

    It will be interesting to see what develops but I’m not sure if “peer-to-peer” loans aren’t just another solution in search of a problem. I know that closing on a bank loan can take time and they require a lot of paper work but a lot of that is a smoke screen to create banking credibility. Banks don’t need to take so long and don’t need so much documentation because the truth is that most of the money they lend is virtual (fractional reserve lending), so if they don’t get paid back they don’t really lose anything except the interest they might have received (opportunity costs).

    However, the fact that peer-to-peer lending involves the transfer of the full loan amount – and therefore creates a real liability for the lender – I would think they would have to have sufficient documentation to determine credit worthiness and lien rights. What I’m saying is that one way banks could compete with peer-to-peer is to lower their standards and requirements. It would basically be a contest between those who lend something created on demand “out of thin air” and those who lend something already in existence and want it back. It will be fascinating to see the possibility of bank loans becoming basically unlimited checking account credit lines versus having to deal with serious lenders who would have a more legally substantial claim on one’s assets.

    • Philippe Gastonne

      Good thoughts. However, if banks don’t really lose anything when a loan isn’t paid back, why that mortgage panic in 2008? Banks were obviously quite worried about hits to the balance sheet.

      • Bruce C.

        Good question. When a bank grants a loan the loan amount is considered an asset on its balance sheet (because it’s considered a source of income) and the “funny money” that’s created by entering digits in the borrower’s account is considered a matching liability. Now, once the loan is created basically two things can happen, the bank can “keep” the loan as its own asset or it can “sell” the loan to a third party (usually to a big Wall Street dealer bank that bundles such loans together -creating a Mortgage Backed Security (MBS) – and either keeps them for its own portfolio or sells them to investors (e.g., pension funds, mutual funds, etc.)

        If the originating bank keeps its loan then loan payments from the borrower are booked by separating the principle re-payment portion from the interest portion. The interest portion is added to its “cash” asset and both the loan-liability and loan-asset sides of the balance sheet are reduced by the amount of the principle portion of the loan payment. (For example, if a loan payment is $100 – or $1 in principle re-payment and $99 for interest – then the banks cash account increases by $99 and the loan balance (asset) and loan liability (virtual) is reduced by $1 each.) If the borrower defaults then at some point the loan asset and liabilities are zeroed out (“written off”). The bank then has whatever interest payments were paid along with the whatever collateral backed the loan (real estate in the case of a mortgage.) Therefore, for zero real cost the bank ends up with some cash and collateral in the case of default. Up until then, however, the bank does not receive any income from the borrower and so the originating bank’s expenses are not funded which created a liquidity crunch for the originating banks in 2008.

        Now, if the the originating bank sells its loan then it gets the value of the loan plus an additional amount in lieu of future interest payments. Not bad for lending nothing. No wonder banks like to sell their loans. However, the buyer of that loan becomes a kind of bond investor who expects to receive future income for the cost of the loan, and the value of that loan/bond then becomes subject to the credit quality of the borrower and the value of the underlying collateral that backs it. Many of the buyers were dealer banks themselves who – because the Glass-Steagal act was suspended – were allowed to trade and invest for their own (banks’) benefit. The money they used was not created by them but was from their own cash accounts and/or their customer’s. In 2008 both income streams began to fall as people stopped making payments AND the values of the real estate backing the loans fell in value, and both factors caused the value of the MBS’s (i.e., RE bonds) to fall precipitously. Another factor was word got out that the securities were not rated accurately. A lot of sub-prime “paper” was A-rated and when the markets learned otherwise MBS’s fell in value even more. Institutions and investors owning those “toxic” investments lost money – at least on paper. That did, indeed, cause problems on their balance sheets. Because the loans were bundled there was no transparency to sort it all out. Rather than letting big bank bond investors absorb their loses the normal “mark-to-market” accounting rules were suspended so that the value of the underlying RE was pegged at 2007 prices, and then the Fed began bailing them out by exchanging the MBS for newly “printed” money as part of its quantitative easing (“QE”) programs.

      • dave jr

        By banks, what is being referred to here? There are Commercial Banks, Savings and Loans, Credit Unions, Private Trusts, State Banks, Wall Street investment banks, Central Banks, the International Monetary Fund, the BIS and World Bank…maybe more. Are they ALL criminal to the core? How do we draw a line when government(s) is(are) in league with the criminal element? What the hell is a bank anyway? Can/could they exist without government guns bolstering monopoly/oligopoly? And why did our free enterprise way of life come to depend on, and hang on the very breath of a Fed Chairperson for our well being…for our mere existence in commerce?

  • Laird Minor

    Banks are indeed being pressured by peer-to-peer lending sites and similar forces. But that in itself won’t doom the banking industry. If “the core of banking is to connect lenders and borrowers” (and I agree that it is, although banks do far more than that), there will still be a need for an intermediary in most such transactions. First, when you are lending money to a stranger there must be some means of assessing his credit quality (ability and willingness to repay the loan), as well as determining the value and sufficiency of any collateral offered. Most people aren’t competent to do that on their own, and most people wouldn’t want to take on that chore merely to make an occasional loan. It requires an intermediary with specific expertise. Second, for a large loan it is necessary to aggregate money into a pool to fund the loan. Peer-to-peer networks may take on that task, but by definition they are now functioning as an intermediary (who must be paid). Third is the problem of liquidity. If you’re going to tie up a significant portion of your assets in a private loan it reduces your cash in the event of emergencies. In such a case you would be in the position of having to sell the loan, probably at a fire-sale price. Having that loan held as a part of a large, liquid pool (i.e., in a bank’s portfolio) minimizes (although certainly not eliminating entirely) that problem. And finally, there is the problem of risk. It is far better to have financial exposure in the form of tiny pieces of many loans than 100% of a single one. A bank is one way of accomplishing this. Certainly there are other ways (non-bank lending institutions, securitizations, etc.), but all require some form of intermediary. All of these issues can be handled by other types of institutions, but when (for the sake of efficiency) you combine all those functions into one entity you have now created a bank.
    Modern banking arose to fill a legitimate need. That need still exists. Peer-to-peer lending is probably going to take a bite out of banks’ traditional lending business, but it will not be a significant one. Banks have learned to coexist with non-bank lenders (and with non-bank depository institutions, for that matter), and they will find a way to survive this threat, too.

  • alohajim

    Will peer to peer lending upset the banking industry’s hammerlock on humanity? Well I sure hope so. And, no, I would not wish Jamie Dimon well. Mr. Gastonne is too nice imho. Modern banking, i.e. the sole right to create currencies from nothing and charge the world ‘interest’ on it, is an abomination that should never have had a chance to see the light of day. The fact that so few people understand the massive transfer of wealth and complete control of governments that modern banking enables is the single most critical issue on the planet. The banking families that own the world’s central banks have only one concern : that enough of humanity will overcome the incredibly efficient and successful con job put over us by the ‘one voice’ of academia, the media, the entertainment industry, corporations and governments and wake up.

    • Randy

      Yes, I’ve been asking various people this question for quite some time now; FROM WHERE do the additional bookkeeping entries come from in order to pay “interest” on a loan? If you create a loan out of thin air for me, and you then fund it with bookkeeping entries that were also created out of thin air, then who creates the additional bookkeeping entries that are needed for me to pay you the “interest” on the phony loan??
      No one yet has been able to give me a logical explanation for that question because it forces them to wake up when they want to stay asleep! But the answer is this, from even MORE phony, fictitious, fraudulent loans that are created out of thin air! This is why more and more bogus debts must be created and enlarged year after year, to keep the Ponzi banking scheme from collapsing, but when too many people wake up to what’s going on, the whole thing falls on its face! Which is what we are seeing right now.

      Randy

  • Injun Holbrook

    Peer to Peer Lending is simply another word for syndication. I syndicated development loans and debt 35 years ago. The banks are the biggest syndicators on earth. They simply are going to wait till all the Peer to Peer regulatory snafu’s are ironed out and use these platforms. They already have funded many of these platforms and own and or developing others they control. While the regulatory freedom to allow non accredited investors into these platforms is a start, that market is very small. People forget that these Peer to Peer platforms need money and the more successful ones will need a lot of money. That money has to come from the public or it comes from the banks. I’ll give you two guesses who is going to provide that. The banks are not going anywhere, they simply are going to adapt and control, besides if they want to close their neighborhood banks and still funnel money to the average syndicated joe it’s a great and cheap distribution. There will be other players but you can bet your sweet t-bill that the banks are already all over this one.

  • TG Molitor

    The world’s largest peer-to-peer lending online platform is The Lending Club. Website: https://www.lendingclub.com/
    It went public last year (the only online P2P lending company IPO so far) and has funded over $11 billion in loans since its beginning (2007). It’s revenue line is straight up, having doubled its revenue from 2013 to 2014, though you can buy its stock today at a 23 percent discount to its IPO price ($15). The winners in this category will be gobbled up by the Big Six banks as a competitive flanking strategy for sure.

  • Danny B

    There is a consistency in home valuation,,, just not at present. The average house has to be affordable to the average worker. The banks have tried to get around this but, it just isn’t going to work in the long run. “Property prices in Japan are so high that mortgage terms of 100 years are commonplace.” https://www.justlanded.com/english/Japan/Japan-Guide/Property/Introduction
    The coming bust is going to destroy the credit structure. It will NOT be easily revived. Once all trust is gone, it can’t be easily replaced.

  • william beeby

    Lending that doesn`t involve interest charged fiat money has got to be good.

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