There is a buzz around peer-to-peer lending right now. New entrants are piling into the market, and a few former bankers are reinventing themselves as peer-to-peer financers — former Lloyds chief executive Eric Daniels recently joined Wellesley Finance, and former Mizuho syndicate man Andy Sweeney has resurfaced offering retail-sized exposure to aircraft leases.
The sector has the excitement of old-fashioned lightly regulated finance, with a touch of Silicon Valley glamour and a package of tax breaks to come. The ever-adaptable securitization industry is preparing to supercharge investment in peer-to-peer, channelling institutional money in the market.
It was in this context that my colleague Jon Hay argued that, rather than reinventing finance, the peer-to-peer lenders were simply reinventing banking — in undiversified, high risk, low capital, unregulated form.
It’s true there are similarities between P2P and banking, especially when lenders start putting their own funds into loan books in a first loss, and funding with fixed rate bonds, rather than passing through entire credit exposure. There are certainly enough similarities that it is worth reminding P2P lenders, again and again, in heavy bold lettering, that their investments are unprotected by any sort of deposit guarantee scheme.
But P2P and banking are also different, in two crucial ways.
No money created
The first difference is that peer-to-peer lenders cannot create money, at least not in widely accepted form. The economist Hyman Minsky once said: “Everyone can create money; the problem is to get it accepted." This is a superpower that banks enjoy, by virtue of being regulated institutions with access to settlement systems. A banking licence is in the most literal sense a licence to print money.
When a bank makes a loan, the money that it credits to a client’s bank account is new money, electronic numbers on a screen. It simultaneously creates an asset — the loan — and a liability, in deposit format. The bank’s capacity to create money is limited as part of the regulatory compact, but it can do it.
This arrangement has been criticised from both left and right — Ayn Rand and Occupy Wall Street coming together — but it nonetheless accounts for 97% of the money in the UK, according to the Bank of England.
A peer-to-peer lender, meanwhile, can only move money from one bank account to another. When it makes a loan, it transfers money from a series of holding bank accounts, or a pooled holding account, to the bank account of its client.
This makes P2P less useful to the real economy. Lenders are not creating money in response to underlying growth or demand for credit, they are simply unclogging one channel between savings and investment, in a particular maturity, looking for a particular risk-return profile.
But it also makes P2P safer, in the aggregate. Without money-creating powers, P2P can only ever be a handmaiden to credit bubbles. Lenders cannot leverage up indefinitely, because all the money funding their loan books must be created elsewhere.
P2P might end up providing an easy conduit for institutional money, excess savings from currency imbalances or the excess liquidity created by years of low interest rates and central bank money creation, but they need leverage from elsewhere to do real damage.
Lend long, borrow long
The second important difference between banking and P2P is the lack of maturity transformation. While society at large, households, corporates and almost everyone else prefers to save at short maturities and borrow for the long term, banks take the other side of the trade, and get paid to do so.
Regulators want banks to do this less, because it is usually taking this side of the trade that blows them up. The underlying cause of a bank going down might be huge losses on poor quality loans, but the proximate cause is usually not being able to roll funding.
Tinkering with the rules of capital markets can help a bit — funding 25 year mortgages with pension fund money, rather than sight deposits, makes the system safer — but maturity transformation is still an important service, for as long as everyone else in the world wants to lend short and borrow long.
Peer to peer lending might evolve to offer more maturity transformation (at the moment, most loans offer none, because they simply pass through loan exposures) but they are limited in the same way as other non-bank financials by the willingness of markets to offer them funding.
If they want to imitate the banks and borrow short to lend long, they must convince the market (or a bank) that their business model works.
Some dumb money might overlook this flaw, but a regulated bank comes with a deposit guarantee and access to central bank facilities — tacit recognition that maturity transformation is such a crucial public good that the state will underwrite it, provided banks play by the rules. It is no contest which institution will extract most juice from the maturity mismatch.
The bank, in turn, accepts it must exist within the regulatory perimeter, in return for its superpowers and for the power to create money.
Less useful but less dangerous
As Jon Hay said, " bankishness " is one of the more appealing characteristics of P2P lending. But the latter remains crucially different — less useful, and less dangerous, than banking.
P2P lenders need not operate within the regulatory perimeter, because their capacity to wreak havoc is so much weaker than that of banks, and because the service they provide is less important than that offered by banks. The sector will only ever exist on the margins of banking, feeding borrowers and savers in areas abandoned by the banks.
While this might mean concentrating on higher risk lending, without the twin turbochargers of state-backed maturity transformation and state-sanctioned money creation, P2P lenders cannot be anything like as systemically important as banks.
We ought to recognise this difference — and make sure we keep such lenders away from the regulatory privileges the banks enjoy.