Commentary

By Tom,

Banks – do we really need them?

Banks are one of those day-old institutions, along with government and taxation, which have been around so long it’s hard to imagine life without them. We tend to accept them as staples of modern society and consequently never really question them or consider alternatives – if indeed there are any. For now, as much as it may hurt, we’re forced to accept government and taxation; but what about banks? Where we choose to put our money is one thing we do have control over and, in recent years, a lot of people have begun to doubt the trustworthiness of the banks. Why is this? Well, the banks gambled, in an increasingly irresponsible manner, with their customers’ money which eventually, along with other factors, led to a crash – causing widespread concern over the future of the High Street Banks. As we know, Our Government promptly bailed them out, supposedly acting in the interest of the public, allowing them to go on trading and, despite the Government’s prior assertion to limit or forbid unethical bonuses, continue paying themselves huge bonuses each year. How big? Well, just last week, Barclays released their most recent bonus figures: £40m, split between nine top bankers – ironically (and suspiciously) announced on budget day, a time when the rest of us were preparing to tighten our collective belt. Seems remarkably like another case of bad behaviour being rewarded. Seems like the banks can act as irresponsibly as they like with our money and, when the chips don’t fall in their favour, they suffer no consequences. Instead it’s the taxpayer who’s forced to foot the bill. If this is the case, then it’s no wonder that many people are feeling disillusioned with the banks. Despite the loss of faith, most feel they have little choice but to grin and bear it, because of our presumed dependency on the banks. But are we so dependent on them? What alternatives to mainstream banking are available to us? Zopa logo insertWell, one key alternative to traditional banking is peer-to-peer (P2P) lending, a form of crowdsourcing which has grown in popularity since its 2005 launch by UK based company Zopa, who have since collectively loaned out a substantial £300m to a user base of approximately 500,000. P2P companies act as online intermediaries between otherwise unrelated borrowers and lenders. Put simply, instead of borrowing a thousand pounds from one bank or creditor, a borrower can essentially borrow one pound from a thousand different lenders (or peers). This highly reduces the risk for the lenders, because, in this scenario at least, if a borrower defaults on the loan they only stand to lose a quid each. And, due to the reduced risk, the borrowers get a much better rate of interest – typically less than 10%. Think of it like a bank run by the people, for the people. Aside from the obvious financial benefits, P2P also presents us with a welcome opportunity to keep our money away from irresponsible bankers. The benefits are pretty obvious – better rates than the banks. The risks, however, are a little less clear. As a lender you are in control of your own risk, to a certain extent, in that you can choose how you want to distribute your money; if you spread your cash out sparsely, lending to many borrowers, then your risk of losing a considerable amount of money is relatively low, whereas if you choose to ‘put all your eggs in one basket’, so to speak, the risk of financial loss is a little higher. Although, in reality, the chance of any borrower defaulting on a loan is pretty low given the strict screening process all potential borrowers must go through – Zopa, for example, turn away 75% of borrowers who apply for credit – and the resulting low default rates (Zopa: 0.5%, Ratesetter: 0.35%). Along with the risk of a borrower not being able to repay a loan, there is also the possibility of the company going bust. Interestingly, this would not revoke the obligation of any individual borrowers to repay any loans they’d taken out to their lender, as an agreement would remain between them, but it would mean that any money that had been invested in the fallen company, but not delegated to a lender, would be lost. The best way to avoid this is to choose one of the bigger, more reputable companies (such as Zopa, Funding Circle or Ratesetter) who, given their current form, are unlikely to go bust anytime soon.
In our next article in the series Banks – do we really need them?, we will be looking into the ‘crypto currency’ known as the Bitcoin.

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