Where is Your Next Whack-on-the-Side-of-the-Head Going to Come From?

In a recent issue of The Economist I saw a whole section devoted to what has become known as “shadow banking.” This is currently a small – but fast-growing – industry that has sprung up since the beginning of the financial crisis in 2008, and involves picking up business that traditionally was done by the banks. My favourite example of shadow banking is peer-to-peer (P2P) lending, where people with spare money can lend it to other people who are in need of money, at favourable rates and less hassle factor to both parties.

But there are many other examples of shadow banking: if you are a reasonably large company looking for a long-term loan over ten years or so, the traditional banks are seemingly not interested, even if you have a solid record. Another one: financing your start-up company has never been as easy as it is right now, with many websites, and even TV shows like Dragon’s Den, offering people with innovative business ideas seed capital from private funds in order to get going.

The Economist article estimates that right now shadow banking in all its forms is responsible for about 25% of all banking and financial services activity in the world, but it will become even bigger and surpass the total banking industry soon.

I don’t normally like telling people, “I told you so,” but I will make an exception this time – to the hundreds of senior managers from the big banks to whom I have spoken to in the past twenty five years. Ever since I saw the first article on ZOPA, a P2P lending company on the web a decade ago, I have been urging all of our bank clients to take action, because it just felt right to me. It sounded then – and now it’s proven – that there are alternatives to traditional banking models.

The traditional bank model works like this (for example, if you decide you want to buy your retiring neighbour’s house):

  • Come into our branch where we will do the best to make you feel humiliated and embarrassed by our power and your powerlessness.
  • Next, fill in a bunch of forms with details like how many hairs exist on your big toe, and how many squares of toilet paper you use when you go to the loo. Bring documentary proof of everything that has happened to you in the past five years.
  • Next, we may or may not decide to lend you money, no matter who you are or what your history is with us, and the decision is based on a secret formula which is known only to a few secretive people who you will never have a chance to talk to.
  • If we decide to help you, you will pay our non-negotiable interest rate which we can change randomly, and if we even get a whiff that something is wrong with you, we will recall that loan at a moment’s notice, or declare you bankrupt.
  • Now, if that’s acceptable to you, sign this contract which nobody really understands, and, by the way, we insist that you also buy insurance from our sister company so we can also squeeze more money from you.

I know that this may be a little exaggerated, but this is what my perception was when my neighbour did indeed retire, and offered me the first chance to buy his house. What would have been a lovely nest egg and a great inheritance for my kids slipped through my fingers, and what’s left is a bitterness towards all banks and bankers.

What are the advantages of this new shadow banking model to customers? (By the way, the term “shadow” is used by bankers rather than by clients, reflecting how they feel about this golden dawn.) For borrowers and lenders, there are distinct benefits:

  • First, as a customer, you can avoid most of the embarrassment, humiliation and sheer effort described in the above scenario.
  • You are also able to get a really nice interest rate that you have negotiated with the lender or lenders. (In some cases, there may be a few dozen people who finance your new house.) Similarly, the lenders get a much better return on their funds rather than leave it in a bank account earning close to zero percent interest.
  • All parties can therefore feel secure that they don’t have to sponsor thousands of employees, (who simply must have a daily fix of cappuccino in the cordon bleu dining room,) a branch network of hundreds of outlets all over the country, out-dated legacy ICT systems that simply don’t work too well, a magnificent head office that sits on the most expensive real estate in the country, (and is used to impress executives and competitors alike,) and overseas jaunts for staff that meet profit targets – but whose customer satisfaction ratings are poor.
  • The new way of doing things means you will be treated with respect and care, and you will know that the profit made does not go to wasteful expenditure and a handful of extremely wealthy shareholders.

Is there some risk involved in this latter scenario? Perhaps, although most of this new internet industry does mitigate risks by asking the parties involved to sign a contract, does credit checks on behalf of users, and takes care of the monthly drudgery of sending statements and collecting funds.

But here’s the scary part: I have picked on banks and the banking industry for this article, admittedly because they are a great source of frustration in my life, but you need to ask, “Is this happening in our industry right now?” Whatever you do to make a decent living right now, whether you manufacture stuff, deliver stuff, sell stuff, or provide professional and other services, your industry has, is or will be seriously disrupted by some smaller, hungrier, younger competitor. In fact, most of you reading this – including me – can easily be replaced by a R4000 microprocessor.

Right now in some board-room, coffee shop, garage or kitchen table is someone who wants to take your business away from you. The only people who can protect you from this onslaught are your customers. As Gary Hamel wrote, “…Out there…[there’s] an entrepreneur who’s forging a bullet with your name on it. You’ve got only one option now – to shoot first. You’ve got to out-innovate the innovators.”


Back to Articles and Resources.