I recently was asked to serve as moderator-discussant on a panel at the first Annual Conference of the Cambridge Centre for Alternative Finance. What I took away from the presentations is that alternative finance, such as crowdfunding and peer-to-peer lending, has been growing rapidly over the past years, though from a small level. And this is only part of a wider trend towards non-bank financial services, which also includes innovative payment services, such as mobile money. Having worked in this area extensively from an African viewpoint, it was interesting to compare notes with other regions of the world.
Turning more specifically to alternative intermediation models such as crowdfunding and peer-to-peer lending, It is interesting to note that there has been an increase in the volume across three very countries and different regions – in the U.S., in Europe and in China, where each region has experienced quite a different financial sector development over the years since 2008. China has seen an asset price and lending boom while at the same time the banking sector has been subject to restrictions, which might explain why some of this additional lending has come through these alternative intermediation models. Many countries in Continental Europe have been suffering from bank lending retrenchment, while SME lending has never been strong in the UK, opening a market niche for alternative financing forms. And the U.S. has always been open to non-bank and market-based finance, given its historic antipathy against big banks.
Based on the different country experiences, one can paint both a bright as a dark picture of these alternative intermediation forms. On the one hand, these innovative platforms provide welcome competition for banks and might expand access to external funding where it is most needed. On the other hand, one wonders how sustainable these platforms are across a full financial cycle. Also, when it comes to lending platforms linked to banks, is this a form of regulatory arbitrage exploiting lower capital requirements outside the regulatory perimeter? This trade-off relates to a broader trade-off on financial innovation, as documented in this recently accepted paper on financial innovation (forthcoming in Journal of Banking and Finance). On the one hand, financial innovation helps countries exploit growth opportunities by completing markets, allowing diversify and hedge risk better and ultimately improving resource allocation and growth. On the other hand, financial innovations can help feed credit booms and help banks take more aggressive risks resulting in tail risks as materialised during the Global Financial Crisis. .
These different views on the alternative intermediation models also see a very different role for regulators. On the one hand, a laissez-faire, hands-off approach, which limits prudential regulation to deposit-taking institutions. On the other hand, a more cautious approach that considers potential fragility risks developing in unregulated segments of the financial system.
Where does this leave the regulator? As argued in this task force report at the Center for Global Development (which I was proudly part of), financial innovations call for a risk-based and functional approach to regulation, ensuring that functionally similar services are treated equally as long as they pose similar risks to the consumers of the service or to the financial system as a whole. For example, payment services must receive identical treatment, whether the provider is a bank or another kind of institution and whether it operates online or from a brick-and-mortar office. It also implies that the regulation depends on the type of services offered by providers, with only deposit-taking institutions that are part of the financial safety net receiving the same kind of prudential regulation as banks.
On a final note, this conference on alternative finance showed again the win-win-win proposition that cooperation between academics, practitioners and policy makers constitutes. Drawing on data from practitioners and questions from them and policy makers, academics can help formulate policy and help the innovation process.
30. Sep, 2016