The Future of Lending

Happy Friday everyone!

Before I start, all the below is based on personal experiences and piecing together various puzzles in my own mind. None of it is research based or referenced. This should hopefully make for more colourful reading. I do believe for everyone on my mailing list, it should be of interest. So, it will be worth bearing with me.

More often than not when people are attempting to borrow money from banks, you will always hear the same complaint about how useless they appear to be and how slow they are, and they don't understand what they are doing.

I believe that the process of lending money has changed drastically over the last 20 years and understanding why this is, may help people be a bit more understanding and sympathetic with their banks when applying for loans. The same reasons that make them appear slow and incompetent may also be a reason why the future of lending around the world could look very different.

To understand what I am getting at, we need to understand what banks are and what a banking license allows a bank to do. Banking licenses are very powerful things and can give companies the power to do almost anything with money across the globe. This is why the South African Reserve Bank ("SARB"), via the Prudential Authority, is very particular about who owns the companies that have these licenses. And unfortunately, the SARB is the reason that banks are becoming more and more frustrating to deal with, albeit that the SARB does have the correct intentions behind this. It is an unavoidable necessary evil once you understand it.

The most sensitive of the powers that a banking license grants is the ability of banks to take deposits from the man on the street and pay them interest. Depositors are anyone with any amount of money in their current/cheque account. Banks then need to use this money to make money and put back into the market through loans and investments where they should hopefully make a return that is higher than the interest they pay their depositors.

This ability to make money off other peoples' money has become increasingly monitored and controlled by the SARB, with the assistance of our strong National Credit Act ("NCA"). The reason the powers that be are controlling and monitoring this closer than ever is because they are protecting the man on the street that has trusted these banks with their money. They do not want banks to be able to lend recklessly and put the depositors' money at unnecessary risk. Once you understand this reason, it becomes easier to sympathize with the banks and their increasingly arduous processes of having loans approved. They may be frustrating you on one side, but it is because they are protecting you on the other side. A good saying that is often used at banks is the "return of capital" is more important than the "return on capital". Basically, saying that they need to worry about getting the money back before worrying about whether they will make money on the deal.

Banks are constantly playing a balancing act of making sure they are not lending recklessly because if word gets out, then depositors will stop trusting them with their money and banks will have a run on their deposit book therefore dropping their liquidity and their ability to lend money to make money. It is a constant battle of protecting money while trying to make money.

Unfortunately, what this drives is a reduced ability of banks to do any lending where they can take calculated risks and charge higher interest rates and fees to make more money. And unfortunately, this sector of lending is what can really drive an economy through growing of industries and improving access to services to previously under serviced areas and creating jobs etc.

By way of an example, if you are buying an investment property or a business for R10 000 000, the banks will probably only be able to lend you somewhere between 50% and 70% of what they deem the value to be. That means you may be required to put in R5 000 000 towards the purchase. Having cash resources available for this is often the main stumbling block to these purchases. Essentially it can drive a system where only the rich can access funding for investments and simply get richer off this (remember the article I wrote on the "Power of Property Debt"). The banks need to make it as certain as possible that they will get their money back so they will be able to pay the depositors when and if they call for their cash. And if the underlying investment is only good to recover 50% to 70% of the total amount in a forced sale situation, this is the most they will be willing to lend, and the SARB monitors this closely. To lend more than this, the banks need to look for alternate security on the amount above these levels, through guarantees from strong balance sheets or additional assets that could be offered as security. Not an easy one to achieve, especially when you are starting out.

Certain banks will still be willing to advance higher percentages to certain groups or individuals that prove they can repay the debt if something had to go wrong. And the banks will charge premiums for this, but it will become increasingly hard to have access to this level of funding.

A further problem that I realised, is that the government, via the SARB, is putting massive pressures on the banking sector to lend into the Small to Medium Enterprise ("SME") sector. They know that growth in this sector will be a massive driver of employment in the country and they do not have the ability to fix it as quickly as getting access to money in that sector will. This is a great narrative that makes for happy reading. Sadly, the same organisations that are putting pressure to lend to these sectors are the ones that make it almost impossible to lend meaningful amounts to these sectors.

The opportunity that this does present is that the future of structured lending, or any lending that has something interesting attached to it, will fall into the private sector, to companies that have credit licenses but do not utilise depositors' money to lend out. These loans will still be subject to the NCA, but because they are essentially using their own money to lend out, they will have the ability to take calculated risks and do things a lot quicker than traditional banks. Clients will pay a premium for this, but on good deals, these premiums are still affordable. Also bearing in mind that without this type of funding, investments will often have to be missed. So, the premiums become very acceptable once you accept what the funding is allowing. A favourite saying of mine is that 10% of something is better than 100% of nothing.

These private sector lenders already exist, and more are popping up regularly. These companies will generally all have their sectors that they prefer lending to, i.e. industries that they know and understand, like property, private equity (businesses) or trade finance. That way the people assessing the deals are arguably experts in their industries and have an improved ability to assess the risks and ensure that they will be able to get their money back and are therefore willing to lend money to these industries.

So, what does this all mean for lending in this country, and possibly across the world? I have a theory that our traditional banks will continue to do what they do. But will be forced to take increasingly less risk with the general market and will continue to lend low margin money for things like purchasing your home or your car. They may increase their lending amounts/percentages, provided you can prove the ability to repay it, but these interest rates will always hover around the prime lending rate and the rest of the costs are governed by the NCA so banks will not make a whole lot of money off these deals. But with a big enough book, it should still be worth their while.

Any interesting lending will slowly start moving into the private sector, which should hopefully remove a lot of the frustrations being experienced with the big banks, but it will come at a higher cost unfortunately.

It is a very interesting space and one that will take some time to get used to, especially from the old days of "we used to go to the bank manager, and he would give us whatever we wanted". Unfortunately, those days of reputational type lending or track records are over, as frustrating as it may be for the generations that came from those times. The sooner we accept the current situation and work with it, the sooner we can carry on working and growing ourselves and our economy.

Please feel free to call me to discuss any of the above, I would love to have the discussion and hopefully learn more about this from anyone that has an interest.

Thanks for reading all the way!

Grant Gibson - Fever Tree Investments

Email: grant@feverthree.co.za
Cell: (+27) 76 122 4451 
www.feverthree.co.za