After bringing our financial system to the brink of collapse, banks are finally facing tougher regulation.
The biggest changes in the banking industry from 5 years ago restrict proprietary trading and demand higher capital requirements.
Without the profit center of proprietary trading, banks are focusing more on their traditional core operation, borrowing and lending money.
By acting as financial intermediaries and facilitating the efficient use of capital to the benefit of society, banks are, well banks again.
It should not come as a surprise then to hear issues with higher capital requirements.
Higher capital requirements require banks to keep more of their money in their vaults to provide additional liquidity for operating losses.
The result has been lower profits for banks, less systematic risk for the economy, and flatline lending growth to borrowers.
Whether this outcome is positive or negative depends on your perspective.
The positive is that our financial system is more stable and banks are not cutting back on lending (as the graph below shows).
The negative is that despite current all-time highs in the stock market, the real economy is still sputtering and lending growth is necessary to accelerate economic activity and achieve full employment.
Chart: total bank credit over the past 15 years in 2008 dollars.
Lending to small businesses
More important than whether we need more or less lending, is ensuring our financial system lends capital to the sources that create the most value.
Entrepreneurs and small business create a net 2 million jobs every year or 65% of all jobs created in the U.S. Small businesses and entrepreneurs makeup the fiber of America – they embody all the characteristics that make America great: individualism, determination, innovation, prosperity, and community.
For every three Americans over the age of 16 earning a paycheck right now, there are two American that are not even looking for work.
The unemployment rate is largely falling because people have stopped looking for work and are no longer counted in the statistic. At a time like this, our financial system needs to be lending to job creating entities.
Unfortunately, that’s not what is happening.
Small businesses are finding it increasingly difficult to come by new capital.
The chart below shows the percentage of nonfarm, nonresidential loans as a percentage of all commercial lending which is a reliable measure, researchers suggest, of small business lending activity.
The trend is clear, less and less money was going toward our economy’s greatest job creators long before the flatline lending growth of the past five years.
In fact, the Small Business Administration claims that there is currently a $100 billion lending shortfall to small businesses.
Classic Opportunity For Entrepreneurial Disruption
Pent up demand and a $100 billion market gap are the perfect combination for entrepreneurial disruption.
Online investment platforms already connect investors to solar projects, consumer debt, and real estate.
And a few companies already have peer-to-business online lending platforms, but what has made news in the past month is the activity of the industry’s two most significant players.
Funding Circle, a British company that has funded $250 million peer-to-business loans in the U.K., last month announced that it raised $37 million in venture capital financing and was buying the American company Endurance Lending Network.
After cutting its chops in the U.K., Funding Circle sees the market opportunity in the U.S. and believes acquiring Endurance Lending Network will give it the ability to compete stateside.
Funding Circle gains country specific and regulatory knowledge from its acquisition of Endurance Lending Network while bringing its own capital and credit modeling expertise to the U.S.
The behemoth in the peer-to-peer lending world, Lending Club, also announced its intention to enter the peer-to-business lending market last month.
Lending Club hired the former head of small business lending at Capital One to lead its small business lending unit that is expected to launch in early 2014.
Lending Club’s entrance into the peer-to-business lending market is significant because of its track record of success in the peer-to-peer space and its deep pockets.
Lending Club has funded nearly $3 billion in loans to date, received a $125 million investment from Google in May, and is expected to go public soon.
Online investing platforms that connect individuals with excess capital to investments previously unavailable or unknown to them, creates additional value that benefits us all.
When individuals lend to small businesses through online investing platforms it creates a win-win-win scenario. Individual investors earn a respectable yield with short duration.
Small businesses receive the capital they need to grow their business faster and at lower rates. And the American economy creates much needed jobs.
Our financial system is still recovering after being brought to the brink of collapse but the entrepreneurial spirit that created America will bring it back stronger than before.
“Is Peer-to-Peer Lending the Key to a Strong Economy?” was written by Boyd Arnold, a member of Mosaic’s business development team. Prior to working at Mosaic, Boyd worked in investment consulting and has experience starting businesses. He graduated from the University of Colorado and has completed all three levels of the CFA. Boyd enjoys cycling, brewing beer, and baseball.
Disclaimer: Any opinions expressed herein by persons not affiliated with Mosaic reflect the judgment of the author and not necessarily that of Mosaic. Nothing herein shall constitute or be construed as an offering of securities, or as investment advice or recommendations by Mosaic. Mosaic’s investments are limited to investors who meet applicable suitability standards based on income, net assets and state of residence. Please click here to learn more.