What are the Dangers of Light Touch Regulation in the Alternative Finance Space?

Interesting piece in the Financial Times recently on the issue of alternative groups like P2P lenders, insurers and asset groups seizing business from lenders by offering cheap and convenient finance. Although they only account for two per cent of market share in the UK at the moment, that figure is rapidly growing.

Of course, with the lending restrictions banks have imposed since the downturn, the finance was always going to come from somewhere. McKinsey’s 2015 global banking annual review predicted that competition from technology companies would hit banks hard, reducing their profits from unsecured lending by 60 per cent over the next decade. But although P2P lending is burgeoning – PWC predicted it will grow to $150 billion in 2025 compared to $5.5billion last year – it still only accounted for 1.1 per cent of the US unsecured lending market last year.

P2P lenders – like Lending Club, Funding Circle and Zopa - say that they can be competitive and offer better deals to customers because they are free of the capital ratio burden imposed on banks, don’t have costly branch networks to fund and aren’t bogged down with legacy IT issues. They can be nimble and fleet of foot. This is a draw to lenders and investors, although only a third of Lending Club’s money now comes from retail investors – the biggest growth group is HNWIs and institutional investors – our pensions.

P2P lenders are capitalising on the fact that banks are reducing the riskier parts of their balance sheets down to increased regulation. And this is the issue for alternative lenders – they can capitalise on lending to higher risk groups because, in the words of the FT, they are “lightly regulated” and don’t need to hold regulatory capital or liquid assets.

So where this “regulation lite” is concerned, could another crash happen because lending is being conducted without effective safeguards? And people can chase risk (with our pension funds) at will? Given the risks we all know too well after 2008, it doesn’t make any sense that these entities are regulated ‘lightly’.

There is a reason that banks are being made to de-risk their portfolios and are being made to hold greater capital. It’s to protect the public at large from risky investing.  

My view is that although crowd funding and other alternative lending arrangements will continue to grow, they won’t be allowed to systematically replace stable well-regulated financial establishments as the primary port for large institutional investing. But given the pace of change in the banking industry, who honestly knows what the future holds?