On my flight to the World Cup this summer, I read an article in the June 18th issue of the Financial Times called “Tough Choices Confront Traditional Lenders”. In it, author Tom Branthworate comments on the lingering effects of the 2008 crisis; mainly, that traditional lenders “are reluctant to lend because their balance sheets are too fragile or because regulators have constrained them.”

As a result of the burdensome regulatory environment, banks often don’t have the bandwidth, expertise, or risk appetite to loan against certain asset classes. Branthworate refers to a system of “shadow banks” – non-bank financial institutions that are less affected by regulations – that have stepped in to fill this void. The term has a shady connotation, and the author notes a degree of skepticism and pushback from traditional banks and regulators. While shadow banking connotes an unregulated financial “wild west” or a black market currency exchange, I see a lot of value in this space. I prefer to refer to it by a different name: Alternative Banking.

Alternative Banking allows for risk to be passed off of bank balance sheets and onto alternative lenders, whether they be asset managers, hedge funds, insurance companies, or Peer to Peer (P2P) and Marketplace Lending platforms. Alternative lenders introduce two main benefits to the financial system:

1) Alternative lenders are experienced in and flexible with managing nontraditional risk that may not fit the criteria and profile of a heavily regulated financial institution, and

2) In the event of a major economic setback or market collapse, the downside risk is contained within a “walled garden” and doesn’t spread its tentacles across a fragile and highly interwoven banking system, causing the sort of domino effect experienced in 2008.

Proponents of Alternative Lending point out that smaller companies and smaller-scale borrowers don’t have access to the capital they need in order to grow. One issue is that small deals don’t always make sense for large financial institutions. Small companies looking for sub $10 million loans have a hard time going to a traditional bank. This makes sense from a bank’s perspective: a bank or hedge fund has to do legal review, due diligence, etc., on every deal they come across. Given the small size of these deals and the expected yield, these deals just don’t make much sense. This is where we believe P2P and Marketplace lending, has the potential to disrupt and to thrive. Small businesses and individuals seeking small loans can tap into the crowd of investors available on these platforms, and find investors willing to take on risk that a bank or fund might not be willing to.

Yield Crowd plays in this Marketplace Lending space, targeting the niche of specialty finance and asset-backed loans. Our team has been personally involved in this marketplace as both lenders (lending to those looking to buy cheap assets, in the form of bridge loans) and borrowers (borrowing capital looking to leverage our inventory of assets that we owned). Yield Crowd opens up the opportunities of Alternative Lending to a whole range of investors and borrowers. In my opinion, the ability to tap the crowd when looking to raise capital and to put excess capital to work at ones own discretion represents capital efficiency in its purest form.

Today, there are close to 1000 crowd or P2P platforms, with about 100 of them focused on debt/lending. The World Bank predicts Peer-to-Peer Lending will become a $900 billion marketplace worldwide by 2025. My personal belief is that this huge projected growth confirms that we are already taking “shadow banking” out of the shadows. What is viewed as a shadow or alternative today may come to be seen as mainstream Specialty Finance tomorrow. A range of lenders outside of banks will prop up and focus on specific niches within specialty finance in seeking attractive risk-adjusted returns. This disintermediation is taking place and will only develop further, allowing banks to be “traditional banks” and alternative lenders to specialize in products that banks never should have been lending to in the first place.