05/03/2015 - 14:03

Bringing banking out of the shadows

05/03/2015 - 14:03

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It is a long time since Western Australia had its own finance industry and while shadow banking, the hottest game in the money world, could be just another fad that fades as quickly as it has grown, there is the potential for home-grown finance to make a return to Perth.

It is a long time since Western Australia had its own finance industry and while shadow banking, the hottest game in the money world, could be just another fad that fades as quickly as it has grown, there is the potential for home-grown finance to make a return to Perth.

A new and less ominous name would be a useful start for shadow banking, which in some ways is just B-class banking but in others could become a significant threat to conventional banks.

Interest in shadow banking, which includes peer-to-peer lending through lending clubs and high interest rate personal loans to people with a poor credit record, is growing around the world, particularly in the US, where technology is making it easier for a group of investors to behave like a bank.

Australia has much tougher laws governing who can call his business a bank, but less-stringent laws governing other types of lending – such as through a credit union or building society.

At this lower level of prudential regulation it is possible to see a group of investors and people with banking skills coming together to create here what is growing rapidly in the US.

No-one expects a quick return to the days when Challenge Bank, Bankwest, Town & Country and Home Building Society gave Perth a financial backbone that made business easier for local borrowers (and savers) by eliminating the frustration of dealing with a remote management team in Sydney or Melbourne.

But it is easy to see a local lending system developing via the use of internet-based technologies and a marketing strategy playing on the fact that a customer is dealing with a ‘bank that lives here’ – to borrow an old (but not longer correct) Bankwest slogan.

What might trigger the birth of a new Perth banking sector is precisely the same set of conditions evolving in the US, where traditional banks are showing the first signs of becoming concerned about the speed at which technology-savvy shadow banks are developing.

One reason for the big banks to worry is that shadow banking (which takes its name from the way it once lived in the shadow of big banks) is tipped to steal 7 per cent of the annual profits currently earned by the banking system.

To put that percentage into perspective, it represents removing $US11 billion from the $US150 billion earned by US banks each year; and while that is undoubtedly a big number, it is actually worse for the traditional banks than simply having less profit to share around, because lower profits affect the prudential ratios by which banks are governed.

Investment bank Goldman Sachs waded into the shadow banking debate this week with a detailed analysis titled ‘The Future of Finance – The Rise of the New Shadow Bank’.

“Regulatory change and new technologies are reshaping competition in traditional bank activities as well as payment eco-systems,” Goldman Sachs said in the 48-page report.

“We expected the competitive landscape to shift over the next five to 10 years, with new entrants emerging and some activities moving out of the banking system.”

The major forces at work, according to Goldman Sachs, are new regulations such as stricter capital requirements for traditional banks, tighter scrutiny around high-risk lending, and changes in the consumer market.

New technologies are also making it easier for shadow banks to steal market share thanks to their lower cost base (no shop fronts), which should make it possible to price loans at lower interest rates.

One of the fastest growing sectors for shadow banks in the US is student loans, with 41 per cent of $US12 trillion advanced to pay tuition fees already in the hands of non-bank institutions.

An example of how quickly a shadow bank can grow is WebBank in the State of Utah, which was founded in 1997 and now has 38 full-time employees and one of the best rankings of income per employee at $US420,000 per head.

Another shadow bank, Prosper, took eight years to reach its first $US1 billion in loans via peer-to-peer lending and six months to reach its second billion.

There are reasons to doubt whether the US shadow banking experience and growth rate can be transferred to Australian conditions, mainly because of the tighter regulatory control of the Reserve Bank of Australia, a factor in this country avoiding the worst of the 2008 GFC.

But there are also reasons to believe that the global technology revolution that is changing every industry will eventually find its way into the Australian banking system.

That could also mean there is hope for Perth redeveloping its own finance sector. It would be small to start with, but local knowledge would be an important element in attracting business if only because anything would be better than dealing with a Sydney head office that shuts at 2pm Perth time.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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