Eons ago I managed a sales team that sold core banking systems to global banks. One sales guy was consistently the best performer. I decided to find out his secret to teach it to the rest of the sales team.
He had found a report that senior managers really wanted and that was easy to create in our system and that was hard to create for our competitors. He had senior management attention and a moat against competition – simple and brilliant.
The report related to Asset Liability Management. So I took a crash course to understand the rather dry subject of Asset Liability Management (ALM). Despite being a dry (read boring) subject, it is key to banking. In short, a bank with good ALM has very low risk and makes good profit and vice versa.
Asset Liability Management 101
ALM is simply matching the Bank’s Deposits (aka what a bank borrowers from Consumers aka a Liability as seen on the Bank’s balance sheet) with with their Loans (aka what a Bank Lends to a consumer or other entity aka an Asset as seen on the Bank’s balance sheet). If Assets and Liabilities get out of alignment, the Bank has high risk. For example if a Bank gets Deposits on a 3 Month Term and Lends them on a 3 Year Term, something could go badly wrong.
Of course, if Banks can borrow on a 3 Month Term and Lend on a 3 Year Term, everything is peachy until too many Consumers ask for their money back at the same time. When that happens it is called a “run on the bank” or systemic risk; Governments and their taxpayers are signaling that they don’t like spending taxpayers money to bail out banks when that happens.
A bank with good ALM poses no systemic risk.
Which brings us to Market Place Lending. People have pointed out that Market Place Lenders don’t pose systemic risk. If a borrower has a 3 year term then the Lender has to have a 3 year term; they have to match or the transaction does not close.
Market Place Lending has perfect ALM.
When you look at Market Place Lending in those terms you can see how powerful it is. In the original P2P Lending model Consumer A Borrows and Consumer B Lends. The marketplace simply matches them. There cannot be any ALM mismatch. If the Borrower wants a 3 Year Term, the Lender has to accept a 3 Year Term or decline the transaction.
As the Market Place Lending market grew, intermediaries such as Banks and Hedge Funds jumped into the Transaction. Now the value chain is Consumer A Lends to a Bank or Hedge Fund who then lends to Consumer B. Of course in our complex Financial System that chain can be longer – Consumer A Lends to Insurance or Pension Fund who lends to Bank or Hedge Fund who then lends to Consumer B. However, as long and complex as that value chain gets, it is still Consumer A lending to Consumer B.
The problem for all the intermediaries in that value chain is when Consumer A and Consumer B figure that out at scale.
“My excess cash flow goes straight to my deposit account”
That is an actual comment from a Pensioner who is living well within his means. He has an old fashioned Defined Benefits Pension that is inflation adjusted. He earns more than he needs to spend.
This is enabled by a Sweep Account – well known to anybody who uses Banks prudently. That Pensioner has his bank automatically transfer money from his “Current Account” to his Deposit Account. (The Pensioner was British, if he was American he would have referred to his “Checking Account”). He knew he was getting a lousy deal on that Deposit Account, but did not fancy the hard work of figuring out how to make good risk adjusted loans via a Market Place Lending platform.
Post PSD2, a Fintech startup could sweep that into a Lending Account based on risk/return profile. That is is the sort of “take something complex and make it easy and intuitive with some UX magic” that digital startups excel at. The prize is big. It could be one of the Deposit Innovators that we profiled back in July who seizes this prize. Or an existing Market Place Lender. This is still a nascent wide open opportunity.
Sweep Accounts into Market Place Lending could eliminate the cost of funds advantage that banks have today and that is a really big deal.
Dear Mr Treasurer, how much do you love your ZIRP and NIRP?
The first to break the dam might be Corporate Treasurers. Like the Pensioner, they know that they are getting a lousy deal on Bank Deposits. Unlike the Pensioner, they have the resources to do something about it. Corporate Treasurers are already doing something about it by lending to their vendors through Supply Chain Finance (SCF). When SCF connects with MPL, the change will come very fast.
Today Corporate Treasurers use sweep accounts to get excess cash into Money Market investments, such as repurchase agreements or commercial paper. SCF is another short-duration investment. However Corporates have excess cash that they don’t need for longer durations so could easily Lend to Consumers or Small Biz for a 1,2, or 3 year terms.
That is why we believe that Market Place Lending is still in its infancy and will fundamentally change the world and why Lending Club could the Priceline of Fintech. (Disclosure I was fortunate enough to buy Lending Club stock at 3.51).
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