Last Saturday I was fascinated – and surprised – by a BBC Radio 4 programme, with a hard-hitting title that I could not have imagined just a few years ago: “Broken Banking.”
The BBC’s “iPlayer” website introduces the programme as follows:
“Big British banks are widely accused of damaging the economy by failing to support their customers. Michael Robinson reports on initiatives to do without banks altogether.
With peer-to-peer lending, borrowers and lenders are matched directly through sophisticated websites promising better returns to investors and cheaper loans to borrowers. Could such direct contacts form a significant part of the future financial landscape? At least one senior Bank of England official thinks it might.”
The programme talked about two such lenders: Zopa for personal lending and Funding Circle for business loans.
I’ve written before (LINK) about this peer-to-peer idea, i.e. “cutting out the middle-man” as we used to say back in the day. Just in case you missed it, here’s that LINK again.
The key question is: how can both investors and borrowers get a better deal? The answer lies in a word: spread.
“SPREAD”: WHAT DOES IT MEAN?
If you were planning an overseas holiday, have you noticed those ads for “no commission” foreign currency; and wondered “how can they do it? How do they make their money?” Well, you know that Thomas Cook, Travelex, etc are not charities; nor is your friendly high street bank, of course.
They all make their money on currency from the difference between the rates at which they buy and sell currency, i.e. the “spread”. For example, if you ask your bank their latest tourist rates, there will be selling rates at which they sell you Euros, dollars etc; and also buying rates for any you bring back. If you work out the difference as a percentage of the buying rate, that’s the spread and that’s how they make their money. If they charge commission as well, that’s a bonus for them (or maybe I shouldn’t use that ugly word nowadays). Maybe they’ll say “commission-free” as an inducement, because they can make enough money on the spread.
WHAT WORKS FOR CURRENCIES WORKS FOR LOANS
Exactly the same thing happens, of course, when banks take in deposits and grant loans. The “spread” between their deposit rates and their lending rates, (or between the rate at which they can borrow in the money market, the now-notorious LIBOR, and the rates they get on loans), is a major part of their income. It’s what would be called margin in most businesses. Fair enough; the banks have to generate margins to sustain their services. But then I got a shock.
According to this BBC programme, the AVERAGE spread at UK banks in mid-2007, just before the credit crunch, was 2%. By 2009 it had risen to 7%.
“That was a rise of over 5%”, the presenter said, but that greatly understates the case. Yes, it was five percentage points, but it was an increase of 250% on the 2007 figure, if I’m not mistaken … in just two years.
This year, the average has dropped to a more “reasonable” 6%. That’s still a rise of 200% on the 2007 spread.
In the clamour for greater transparency about banks’ account charges, the spread figure is another (and probably much larger) area on which the public is mostly in the dark.
What’s the connection with peer-to-peer lending, you may ask. Peer-to-peer lenders simply put two parties in touch, and never handle the money, so they take a commission for the service, instead of a spread. That commission, according to the BBC, averages 1%. Yes, you read it right: 1%. That’s why the borrower and the lender can both get a better deal.
WANT TO KNOW MORE?
For BBC iPlayer, to access the Radio 4 programme, click here:
(Note: most programmes on iPlayer are available only for a week or two but this one is apparently available until 1 Jan 2099!)