“Neither a borrower nor a lender be”

Author

Date

31st January 2017

The phrase “Neither a borrower nor a lender be” sounds both elegant and wise, but if the advice contained in those words, taken from a passage in Shakespeare’s Hamlet, were to be adopted literally, the commercial world as we know it today would come to a shuddering halt. Whether we like it or not, money is the essential lubricant for any business, regardless of size, sector and location.

That is why there should be no shame or stigma attached to borrowing – provided it is for the right reasons and terms are sensible and fair. Right now, the P2P lending sector is awash with both individual and institutional investors eager to secure a reasonable return on their cash in the current low interest rate environment. But SME borrowers are not so plentiful, presumably because they are uncertain about the post Brexit world that lies ahead.

If that is the primary reason for lack of appetite then, if anything, the picture is becoming even more confusing as politicians, lawyers and other vested interests jostle for position on deciding the final terms of the UK’s exit from the EU. But, as those of us in the P2P sector know only too well, there is another, more apposite quote (this time from Benjamin Franklin) that says “Out of adversity comes opportunity”. The unvarnished truth is that, if the 2008 financial crisis had never happened, the P2P sector would probably never have taken root and flourished in the way that it has. So, for that, let us all be thankful.

In the meantime, SMEs, often described as the backbone of the UK economy, should not be encouraged to get themselves into debt simply for the sake of it, or just because the money is available, but to view borrowing as the gateway to growth and opportunity – to invest in people, technology, new plant, marketing, or a new products or services.

The trick, though, is to borrow on the right terms. The banks may be lending more to SMEs than they were, say, a year ago, but often this is not in the form of a straightforward fixed term, fixed rate loans. Customers are often encouraged to go down the invoice financing route, where fees can be extortionate and the arrangement can be difficult to escape from once signed.

The cost of borrowing is trending down because of competition, which is exactly the way it should be. And the ‘one size fits all type of finance’ is a thing of the past; there is an immense variety of options available if you can be bothered to shop around. That lenders will want their money back is obvious, but you don’t necessarily have to give up your precious equity, or risk losing your house through signing personal guarantees, just to gain access to the right type of finance. Alternative finance has brought genuine innovation to financial markets – it would be a pity to suffocate it with onerous regulation.

Conflicting Information

Author

Angus Dent

Date

24th January 2017

It is sometimes difficult to know who to believe when there is conflicting information emanating from two supposedly reputable sources – the pre-Brexit propaganda war immediately springs to mind. In this case, we have the NACFB proclaiming that there is a ‘plethora of lenders’ in the market, while Small Business recently reported that 1,093 small companies are expected to cease trading in January through lack of finance. This sits alongside other, equally alarming statistics such as the fact that 3,633 business failed in Q3 of 2016 and that only 41.4% of UK businesses started in 2010 survived to their fifth birthday.

Of course, some of the companies heading for the drop will not have been up to standard in the first place, but it beggars belief that they should all be in this category. Is it that the owners of these businesses simply don’t know what sources of finance are available and don’t know where to turn? Or is the NACFB mistaken? Either way, there is clearly some kind of information gap.

We know from other sources that, partly due to the uncertainty surrounding Brexit, SMEs are currently of a mind to borrow less and to hold on to more of their cash; according to the British Bankers Association (BBA), SME lending in Q3 2016 dropped 13% against the same period in 2015. The BBA also revealed that SME deposits have risen by 5% to over £170bn.

The trends suggest fear of what the future may hold. Many SMEs are trapped in a cash flow squeeze brought about by staff who expect to be paid monthly and suppliers who routinely pay on 60 or even 90 day terms. What do you do – turn away business that might give you a 30% profit margin or borrow the working capital which may cost the equivalent of 10%? The logical answer may not be immediately apparent to everyone.

Invoice finance undoubtedly has its place in the market, but it is no panacea. Because of the high costs involved in terms of fees and maintenance, at worst it can be an expensive fix that suits the provider far more than it suits the SME.

Subject to appropriate due diligence processes and appropriate security, P2P loans are available to help with a wide variety of problems, including short term cash flow. They are also available to companies that want to borrow to invest and grow. There is no stigma attached to borrowing money for the right reason and at the right price. There has never been a better time.

Disintermediation

Author

Angus Dent

Date

22nd November 2016

There has been much speculation about the potential impact of the IFA and wealth manager communities eventually throwing their weight behind the P2P sector. Why they haven’t done so up until now hinges on the argument that without FCA approval they have not felt able or willing to recommend P2P products to their clients. The FCA’s lengthy deliberations regarding which P2P platforms are granted full authorisation – a process that is still ongoing for most of the major platforms, including ArchOver – have obviously not helped the cause.

Crucially, authorised status will dictate which platforms will be able to offer an Innovative Finance ISA product. It is widely anticipated that, for those who pass the FCA test, this could act as the trigger that will prompt IFAs/wealth managers to give their active endorsement to P2P through IF ISAs. The hope is that, once the regulatory shackles come off, the floodgates will open as lenders/investors pile in to take advantage of tax free returns on P2P loans (obviously within annual ISA limits), which we know would generate far more attractive returns than those based on bank or building society deposits.

It all sounds great. My only question is: why do we need the wealth managers and IFAs now? Surely disintermediation lies at the very heart of the whole P2P lending project – a process by which the investor receives a greater share of the return because the middle man has been removed from the equation.

This can be easily demonstrated in the world of investment management where investors are forced to give up part of their gain in the form of fees. An investment of, say, £100,000 may produce an annual return of 7%, or £7,000. A return reduced to 6%, of £6,000, by fees would mean a reduction of £1,000 in one year alone. Over a period of five years, arithmetic shows that the cumulative loss would be £17,797, assuming annual returns are reinvested. Removing the middle man may involve slightly more effort on the part of the investor – virtually none if you are being charged fees to invest in a tracker fund – but the savings can be considerable. And it makes still less sense to be charged fees in the years when investments fall in value.

And the same applies to the world of debt finance where the banks are a classic case to point. For decades, they have enjoyed low cost of capital which, when combined with the low returns offered to depositors, explains how they can afford to maintain a presence in the High Street.

The internet has been one of the driving forces behind disintermediation – it allows the dissemination of information to large numbers of people at low cost. And the process has only just begun.

To ‘re-intermediate’ by inserting a layer of fee-charging organisations between the client and the product provider – IFAs, wealth managers and P2P aggregators, to name a few – represents an unnecessary step backwards. Those who take the risk should keep the gain

Falling Further Down the Rabbit Hole

Author

Angus Dent

Date

3rd August 2016

The rate at which the Bank of England is prepared to lend short-term money to financial institutions looks set to fall below its current historic low of 0.5 per cent to 0.25 per cent, a move designed to stimulate the stuttering British economy. However, I would argue that further suppressing the cost of credit will do little to help British businesses battling Brexit uncertainty. Instead this rather negligible Interest Rate reduction will inflate the debt bubble while further punishing pensioners and savers, thereby diminishing waning economic confidence; thus costing companies dear. So what is the MPC’s rationale?

In Money Creation in The Modern Economy – a paper published by the Bank of England in 2014 – Michael McLeay, Amar Radia and Ryland Thomas explain how commercial banks create money via the provision of loans to households and companies. Contrary to economic theory outlined in most textbooks, ‘rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits’ (McLeay et al., p.1, 2014). It is thus the commercial banks (not the Bank of England) who create money. The interest rate – otherwise known as the ‘repo rate’ – acts as the ultimate constraint to commercial bank’s ability to create money as it determines the price and consequently the profitability of lending. By lowering interest rates, the MPC are reducing the price of credit and thus imploring commercial banks to conjure up more money by writing new loans.

The MPC hope that more ‘fountain pen money’ – money created at the stroke of bankers’ pens – might help to sand over the cracks our decision to leave the EU has created. It will not. Rather, it is a vote of no confidence in the UK economy, an economy currently plagued by uncertainty. What’s more, it proves we have learnt little from the 2008 financial crisis. As Mervyn King (2010) suggests, ‘for all the clever innovation in the financial system, its Achilles heel was, and remains, simply the extraordinary – indeed absurd – levels of leverage represented by a heavy reliance on short-term debt.’ Would raising interest rates be such a bad idea?