MindBullets 20 Years


Social banking and circles of trust replace consumer savings and loans

Citibank has divested from its retail banking operations and is focussing strictly on commercial and merchant banking activities. It is also seeking to get rid of other ‘assets’ which have been falling fast in value as the banking shake-out continues.

It started with the sub-prime crisis of 2007, which rapidly escalated into a credit crunch.

But the emergence of social lending and peer-to-peer (P2P) financial services put the final nail in the coffin of retail banks.

The enormous success of Facebook and OpenSocial technologies in harnessing the power of the internet to create circles of trust among the new generation of me-entrepreneurs provided the gap for an entirely new banking model – lending directly to, and borrowing from, your ‘friends’ in your network.

Totally secure and private transactions – even on mobile phones – eroded the need for a central depositor. Retail banks are so last century.

Now FaceBank, with more than 200 million customers, is the fastest growing financial services network in history, and Citibank is fast becoming yesterday’s prime lender.

ANALYSIS >> SYNTHESIS: How this scenario came to be

A revolution in lending
Driven by the popularity and real efficiency of social networks, new models of savings, loans and investment have sprung up between those with excess cash to invest, and those needing funding. By cutting out the middlemen and corporate structures, huge efficiencies and cost savings have accrued to the individuals involved. And the internet provides all the security, trust and convenience required.

Zopa, CircleLending (bought out by Virgin Money), Prosper, LendingClub and others all offer variations on the theme of matching up individual cash-rich lenders with needy borrowers, who want to say, pay off their credit cards, start a new business or raise the down payment on a mortgage.

In India, Grameen Bank provides credit to the poorest of the poor in rural Bangladesh without any collateral. “When we started giving out tiny loans under a system which later became known as the Grameen Bank, we never imagined that one day we would be reaching hundreds of thousands, let alone five million, borrowers,” says their founder Professor Muhammad Yunus.

Micro-credit can be a significant force in socio-economic development, especially when facilitated by the connections, controls and network effect of social networking sites like Facebook and LinkedIn.
2005: Social lending makes its debut
A start-up company in Silicon Valley gets the ball rolling. Prosper’s CEO Chris Larsen likes to compare the company to eBay except lenders bid interest rates on loans and the borrower picks the winning bids. He says it is very typical to have between 50 and 100 people lend the money – as little as US$50 each – to a single borrower.

By 2007 Prosper is facilitating loans of US$ 80 million in the US alone.

2006: P2P lending becomes a force in the market
In a growing global economy, there is room for all sorts of innovative ventures, and peer-to-peer lending has the right environment to blossom and develop. Although still in its infancy, it catches on in some markets.

Many countries have a culture of lending within social networks, but it is in the UK and US where the internet is first leveraged to formalize the practice, and turn it into an industry worth US$ 282 million, and growing fast.

2007: The sub-prime crisis
The sub-prime crisis starts in the US, with less-than-fully-secure mortgages moving into default as home owners find themselves over extended. There is a rapid spill over into the UK, with Northern Rock bank experiencing a run, and needing the government to bail it out.

At the same time, markets have been racing ahead all year, all over the globe. House prices are at an all-time high, and stock exchange indexes in major cities are regularly recording new highs. All eyes are on China and India, the fastest growing economies. Even Japan is staging a bit of a come-back, and Russia and Germany are growing.

But some pundits are pointing at growing signs of stress in the US economy. “The dollar is weak,” they say, “and only propped up by China’s capital. US trade deficits are unsustainable. When American consumers run out of cash, the whole economy will falter.”

Such an event would impact on the global economy, and those with surplus funds eye the scene with speculative intent. China is gradually getting out of US Treasury Bonds and into real assets, both in America and abroad. China makes a significant acquisition in South Africa’s Standard Bank – one of the largest branch networks on the continent.

Towards the end of the year, Citibank takes a massive hit as the full extent of its exposure to the sub-prime position is revealed – a US$ 15 billion write-down seems likely. At some banks, capital ratios are dropping fast. The Swiss bank UBS sees its tier-one ratio (which divides a bank’s risk-weighted assets by its core capital) fall from 12.3% at the end of the second quarter to 10.6%. At Citigroup the tier-one capital drops to 7.3% in the third quarter, down from 7.9% in the previous one.

Abu Dhabi Investment Authority (ADIA), a secretive sovereign-wealth fund, comes to the rescue, paying US$ 7.5 billion for a 4.9% stake in Citigroup. Citibank’s shares rally strongly on the news, but concern over the sub-prime fallout lingers.

2008: Credit crunch
The credit crunch takes hold, as US economic growth slows to 1.2%, against all economic forecasts. It seems the American economy was driven by consumer spending after all.

“The reduced supply of credit is contributing to recessionary fears that are greater in America than in the rest of the world, because the American consumer faces an unusual combination of difficulties,” says Ian Shepherdson of High Frequency Economics, a research firm. “Fuel prices are soaring, house prices are falling, confidence is plunging and there are signs that the jobs market is weakening.”

By contrast, corporate activities are healthy. Although the consumer slowdown is hitting retailers and manufacturers, corporate finance is buzzing and the place to be – if you’re a banker. Shake outs often mean liquidations, mergers, acquisitions and distressed-debt opportunities. That’s where the profitable transactions lie.

Vasco Moreno of Keefe, Bruyette & Woods, an investment bank, thinks it will take at least a year of banks reporting decent numbers before an end can be called to the credit crunch. “Roll on 2009,” chorus analysts.

2009: Goodbye Citibank, Hello FaceBank
The new paradigm – lending, borrowing and investing with your friends and business partners – takes over. By spreading the loans in your network, you minimize the risk, and by aggregating sources of capital across your networks, you extend the reach. With no corporate institution to slow down the process and take a cut, everybody wins.

FaceBank launches with 200 million globally connected members – they are not customers, they are participants – in the greatest financial services experiment since the invention of the banknote.

Citibank sees the writing on the wall, and bows out. Luckily for them, there are several Chinese banks desperate to extend their investment in traditional financial assets, who are willing bidders. Gulf investors also seem keen to increase their stake in American banks. Perhaps all these bidders think that peer-to-peer lending is a passing fad and will go the way of the dotcom bust?

Warning: Hazardous thinking at work

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