Those doubting that we live in a ‘globalised’ world would do well to recognise that the Northern Rock mess of the last couple of weeks actually had its beginnings in the credit crisis in the United States.
Across the Atlantic, American lenders lent too much, too easily, to too many sub-prime borrowers. Rather than savers’ deposits, this aggressive lending was funded instead by lenders packaging up loans for sale to banks and other financial businesses, making a profit in the process.
As the lending carried on and interest rates rose, it wasn’t long before this apparent gravy train came off its tracks. Some sub-prime borrowers found themselves unable to service their debts and defaulted, on a scale large enough to cause the collapse of a number of the lenders involved.
So started the credit squeeze. And with the world as interlinked as it is now, the effects were not restricted to the US. Books of dangerous US loans had been bought by firms on this side of the pond as well – and so American sub-prime bad debt issues started to bite right here in the UK.
All this may still seem a long way from the Northern Rock. However, even though Northern Rock was not really lending to the UK sub-prime market, it was using the same ‘never never land’ technique to fund the lending it was doing (and it must be said at some very aggressive interest rates). This meant selling these loans to the same firms that had burned their fingers in the US sub-prime market. Before long no-one wanted to buy, and especially at the prices Northern Rock needed to make their margin on the low rates they had lent at.
Inevitably the crisis hit the media. For the general public, explanations involving the knock-on effect of the American sub-prime bad debt crisis seemed far-fetched, then deeply worrying. “What’s all this about Northern Rock lending out money it didn’t have? And the banks lending between each other? What about UK sub-prime? What the Hell is going on around here?”
The public had always thought that banks lent out the money their borrowers deposited, and made money by charging more interest on their loans than they paid out to their savers. A kind of self-supporting mechanism that seemed to make sense, even if people had become cynical about the profiteering games banks play as rates move around.
It’s old news that most people don’t believe banks operate in their customers’ best interests, and many believe their profits are excessive. But the public had always regarded the banks as safe. Now it turns out they may not be after all.
Worse still, the man on the street can’t actually assess how safe or otherwise they are. The way some of them operate is impenetrably complex, and seems almost deliberately so. People might have become used to hidden catches in the small print, but now they are faced with potentially much bigger problems, hidden away in the banks themselves.
All of this naturally filled the news media with huge scary headlines. Coming in on the recent memory of the Equitable Life fiasco, and company pension shortfalls, Northern Rock’s customers understandably panicked.
Reassurances from the management of Northern Rock were disregarded as swiftly as you’d expect. Similar words from the Government seemed to fan the flames of nervousness and doubt rather than help. In no time huge queues formed outside Northern Rock branches as customers demanded their hard earned savings.
Billions of pounds of withdrawals later and finally the Government and Bank of England stepped in to guarantee the deposits left in Northern Rock. The whole thing looks rather a mess. The ‘blame-fest’ has only just begun…
The banking industry is now left licking its wounds and trying to move on. But its reputation has suffered a real beating. It was regarded with suspicion by many people before. Now it has even greater issues to address if it is to rebuild customer confidence.
In order to rebuild trust, banks will have to become radically more open and transparent. And this means some of the more exotic and opaque practices - like those that caused Northern Rock’s crisis - may have to be consigned to the City’s bin. This may leave some banks struggling on the road back to reality.
Meanwhile, back at Zopa, the last few weeks have served to shed new light on the appeal of Social Lending. Since we launched we have been proud of the innovative way we have created for people to bypass banks and get a better deal directly from each other. And we have done this by lending responsibly, and not to the sub-prime market. This can be seen from our default levels of below 0.1% across all of our lending.
We have also long been proud of our transparency. From very simple, and low charges, through to letting our members see who they are lending to or borrowing from.
But the last few weeks have also highlighted another key attraction of Zopa’s operation - ‘tangibility’. It is easy to see exactly what is going on. People are borrowing and lending between each other, with Zopa making it much safer and easier to do. There’s no highly paid City Slicker buying and selling futures, derivatives, Bizarre Bonds or whatever to make Zopa happen.
Maybe this clarity and simplicity will be our most attractive feature going forward – along with the great rates, of course.