© Justin Tallis/reportdigital.co.uk
August 2007. That is when it began, in the unassuming queues outside Northern Rock. Those lines were the first intimation of how the banks would come to fill our minds, would become the symbol and substance of so many things that are wrong.
Half a decade has passed, and what has changed? There was the emergency: the bailouts and the part nationalisation of RBS. But our collective response seems to have been the construction of a logical trap, in which banks have been cast as both sinners and saviours, saboteurs and engineers of the recovery that we still await. They must be more prudent—but they must lend to get the economy going again. They should never have given us all such easy credit—but they must not touch our mortgages.
That contradiction runs through Britain’s relationship with banks. More than 90 per cent of us have a bank account—compared to less than 75 per cent in America—and almost 70 per cent of us own our homes, more willing to take mortgages than our fellow Europeans. In a nation of 60m, we have 71m current accounts, 60m credit cards and an average unsecured debt (on our cards, in our overdrafts) of just over £4,000 each. We leverage. We play the game. We see what we can get.
And yet, as consumers, we are curiously passive. Despite the encouragement of campaigns such as “Move Your Money,” which invokes Gandhi (“Be the change you wish to see in the world”), fewer than 1 in 20 customers swap banks each year, compared to 1 in 3 who swap their car insurance. Instead, we carry out all of our transactions, all our individual hedges and wheezes, in one of the most concentrated, least competitive banking sectors in the world. Between them, the “Big Five”—Barclays, Santander, RBS, Lloyds and HSBC—warehouse 80 per cent of Britain’s current accounts, 66 per cent of our mortgages, 60 per cent of our personal loans and 70 per cent of our business lending. These institutions could not be more familiar, but we definitely don’t like them. Analysis this summer of customer satisfaction of 48 European banks by Forrester, market researchers based in the United States, found Britain’s banks in the bottom five places. What are we waiting for?
Perhaps it is the revolution in lending that is now underway, triggered by the 2007 crisis, generating a new way of thinking about how to borrow money—from organisations that look nothing like banks. Entrepreneurs, venture capitalists, even anthropologists, are turning their energies to the question. “There is this huge thing going on,” one told me, “a very basic theme, which is that people are losing trust and satisfaction with banks and with financial services and they are willing to try new things.” Many of these new things are not even that new, with their origins in the dotcom boom, the 19th century co-operative movement and the “sub-prime” communities of the American South. But this recession, with its shortage of credit, its surfeit of dismay towards the banking hegemons, has provided the ideal circumstances for them finally to prosper.
Late in the summer, I went on an informal tour of these upstarts. None of them were banks. Nor would they want to be. For now, most of them are focused on Britain’s £200bn market of consumer lending—the vast banking undercarriage of credit cards, overdrafts, car financing and personal loans. Their label, if they have one, is “Alternative Lenders.” But this hides their variety. Some of them are online, and take at least a few minutes to understand; others are as straightforward as could be—look at the hundreds of cash shops opening on our high streets. Some have social missions, others are determined to become the new multinational financial services companies. All are driven by new technology, new norms of behaviour and the emerging needs, some of them depressing, of our 21st century lives. All of them are currently specks next to the “Big Five.” Many will fail.
But some will work. And if they do, they might just have the power to remake the way we look after our own money and borrow other people’s. They could also recast our understanding of what the word “bank” can mean.
The most conspicuous new players are payday loan companies; to many, they are the most unsettling. They do what their name suggests: provide short-term, unsecured loans, normally of a few hundred pounds, to tide people over until the next time money comes in. They are offspring of the pawnshops and cheque-cashing stores of small, poor, American towns. The first US chain got going in Tennessee in the early 1990s and “payday” companies arrived in the UK around the turn of the century. In 2006, they had just 300,000 customers, mostly using small, shop-like operations.
Since then, fuelled by investment, often from the US, and the foul winds blowing through the British economy, the payday phenomenon has taken off. Fed up with bank charges for unauthorised overdrafts and apparently scared of the open-ended obligations of credit cards and store cards, the British public, especially young workers earning less than £25,000, have turned in huge numbers to payday loan companies for short-term cash injections. The last widely accepted estimate for the size of the industry was in 2009, when 1.2m customers borrowed £1.8bn, but the only thing that people agree on now is that those numbers are too small. The Office of Fair Trading, which issues lending and debt collecting licences, doesn’t know how many payday loan companies are operating in the UK. There might be as many as 200. These lenders have met a need—for unsecured lending—that the banks don’t want to meet and which will soon become even less attractive with the introduction of new regulations. The companies themselves reckon they are now providing up to 4 per cent of Britain’s consumer lending, or £8bn a year. The two that I went to see, Wonga and MEM Finance, which operates the brand “PaydayUK,” claim a million customers each.
In the US, payday loan companies offer their services explicitly to the country’s “unbanked” and “underbanked” population. In the UK, the market has been historically served by pawnshops and doorstep lending, itself dominated by a single company, Provident Personal Credit: “The Provvy” to its customers. What is different about the current incarnation of payday lenders, above all the online firms, is that they are tech companies.
Step forward, Wonga. The company’s catchy, almost provocative name; its ubiquitous adverts (puppets of old people, jiggling about to music); and its evident success—Wonga makes 300,000 loans a month at a startling representative annual percentage rate (APR) of 4214 per cent—have made it the place to start for attacks on the payday loan industry. Behind the screed of bad publicity, however, a new kind of financial services company is trying to emerge. “The day job is having to defend 4200 per cent APR, which is rather tedious,” Henry Raine, Wonga’s head of regulatory affairs, told me. “What is really interesting to me is the intellectual journey of where this is going to lead to. Because this is just the start if we get it right.”
Wonga is run out of two Georgian townhouses in Camden, north London. I met Raine at the York and Albany, a Gordon Ramsay pub and hotel that functions as its de facto executive canteen. Wonga’s South African founder and CEO, Errol Damelin, was eating his breakfast at a table outside in the sunshine. Damelin’s initial pitch for Wonga, a 20-slide presentation, without a single line of computer code to back it up, is a legendary event in alternative lending. In 2005, he approached Balderton Capital, a venture capital firm known for its investments in online businesses such as Betfair and Bebo, the social network, with the idea of a website that would offer small loans and transfer money to customers’ accounts within 15 minutes. Britain’s banks thought he was crazy. (Wonga’s first line of credit was from the Bank of Nova Scotia.) Seven years later, doing what Damelin said it would do, Wonga, operating entirely online, has made 5m loans and is valued at around £2.5bn.
The heart of the business is an algorithm. Wonga’s “Radical Risk Engine” weighs 8,000 pieces of publicly available data about its loan applicants, from how long they have owned their car to the bad-loan rate of their neighbourhood, in nine seconds. It combines that score with behavioural indicators from the website (how long applicants hover over particular questions, or change their mind about how much money they want) and makes a decision. If things check out, the customer gets the amount they asked for: the average loan is £255 for 16 days (which costs £301.61). They can pay back early if they want to.
Taken as a whole, Wonga’s service is one that Britain’s high street banks, with their doddery computer systems, could not offer even if they wanted to. “They can’t do it,” said Raine, simply. Every new IT malfunction, like the one that locked 17m RBS and Natwest customers out of their accounts in June, is a reminder of the decades-old systems clunking away in the big banks. “We use the software that banks would like to use,” as another alternative lender told me.
This emphasis on using computing power to deliver new kinds of discrete, fast financial services—more app than bank—is what interested Wonga’s investors, more than the interest rates. “When Errol came into us, we saw more of a consumer internet business than a banking business,” said Barry Maloney, a Balderton partner who heard the initial pitch. Wonga plays to a smartphone, have-it-now generation. It is popular among taxi drivers, and sole traders, for whom cash is always a day away. In May, it began offering fast-turnaround business loans. “There are companies where you think this vision is so big it could be anything,” Maloney told me. Raine talked about the “Wonga dream”: “Eventually, that you could do everything if you want to, through Wonga.”
For all its smarts, though, it is hard to get past the idea that the real animus behind payday lending is financial hardship. “Customers aren’t coming to us just because they are backlashing against the banks,” said Raj Singh, the chief executive of MEM Finance, which will reach £500m in lending this year.. “The first thing is demand. They have a need.” The rise of payday lending in the UK is also the story of the flatlining of the nation’s wages. In its 2012 survey of the consumer credit market, PwC found that 26 per cent of people aged 25-34 (the main group turning to payday lenders) had used credit to pay for essential items in the last six months. Two out of three thought they would be able to pay it back.
Although the big payday companies insist that they do not lend to people who cannot afford it, the sector is undergoing its third review in as many years by the Office of Fair Trading, mostly for targeting vulnerable customers. Singh told me that MEM turns down 90 per cent of its loan applications, but admitted that it only turns a profit on a customer’s third payday loan. When I went to see Gillian Guy, the head of Citizens Advice, she told me about a client with 19 concurrent payday loans and her conviction that the only way the companies made money was by encouraging customers to “roll over” their loans and interest for months at a time. But Guy saw all too well the power of the payday idea: the speed, the sense, not always justified, of control in borrowing £100 and paying back £129.95 at the end of the month. “Once it is out of the box,” she said, “it’s not going back in, is it?”
The Wonga dream is not the only imaginative response to Britain’s hunger for credit. These are also propitious times for the UK’s historically tentative credit unions. A financial innovation of the 19th-century co-operative movement (birthplace: Rochdale, 1844), credit unions in their simplest form are savings clubs. Members with a “common bond”—a place of work, say, or city postcode—pool savings which then enable each other to take out loans, typically at interest rates of 2 or 3 per cent a month. When the union turns a profit, everyone gets a dividend. Over the last 150 years, the model has taken off around the world, in many countries becoming a kind of parallel retail banking system, offering mortgages, life insurance and current accounts. In the US, 40 per cent of the population are members of a credit union, in Ireland, 70 per cent. In Britain, with its Big Five, just 1.5 per cent.
A fast-growing 1.5 per cent, all the same. Identified by Labour in the 1990s as a vehicle for encouraging saving in poor communities, credit unions have been in a phase of creative destruction since the start of the banking crisis. Membership has rocketed, from 650,000 to 1m in the last four years, while the number of unions has fallen sharply in a wave of mergers. Earlier this year, the government got behind the movement, passing legislation that loosened the “common bond” requirement and allowed credit unions to vary their charges. The Department of Work and Pensions has put up £38m to further modernise and rationalise the sector and there is an ambitious plan to connect credit unions through the Post Office.
One morning in August, I went to Leicester to visit Clockwise, one of the new breed of credit unions. Twenty years ago, it was run by the congregation of Sacred Heart, a small Catholic church in the city. Now, with its headquarters in a converted noodle restaurant, Clockwise has 7500 members, a staff of 18 and processes loans in 48 hours. When I arrived, just before lunch, the place was faintly uncanny. Outside there was the Clockwise logo, an owl, and inside, what seemed to be a not-quite-realised version of a generic bank branch. It was like the set of TV show. Or a pop-up. Too beige and ungarish somehow. “Is this a bank?” A woman wearing dark glasses said loudly. A cashier asked her to join the queue.
Upstairs, Jo Purdy, Clockwise’s manager, described the credit union’s tense circumstances. On the one hand, it was growing fast. In the push to modernise, it was conducting more and more of its business online, and was one of 25 credit unions in the country to offer a current account. What’s more, the credit union ethos, with an emphasis on human contact and a sense of community endeavour, was striking a chord in a city fed up with its banks. “There is a huge change going on at the moment in the way that people think about money,” said Purdy. “There is a feeling among the credit union movement that this is our time.” (The feeling is contagious: a credit union for Kensington and Chelsea will open later this year, and the Bishop of Durham is working with the Centre for the Study of Financial Innovation, a London think tank, to investigate the possibility of setting up credit unions in the north east.)
At the same time, however, the very demand that Clockwise was eager to meet was also threatening to put it under water. What members were asking for, Purdy explained, were small loans, in the payday range of £50 to a few hundred pounds. She was keen to issue them, but it was hurting the credit union. Each £50 loan brought in just £1 in interest but cost £60 to process. At the other end of the scale, meanwhile, members were either cutting down on the larger loans (the credit union makes money on loans of over £500) or failing to pay them back. A series of large defaults earlier in the year had already wiped Clockwise’s hopes for a profit in 2012. Expansion, heady as it was, was mightily painful. “You can tell from the way I’ve been talking to you, this is great,” said Purdy. “This is what we want to achieve. But on the other hand it is causing us massive problems.”
Credit unions have political support. They represent a genuine seam of solidarity in hard times. But their survival and development depend, ultimately, on their members’ finances returning to their “normal,” pre-recessionary health. What I found striking about payday loan companies, by contrast, was that they seem built for a future that looks a lot like the present. In the US, where low and middle incomes have now been stagnant, in real-terms, since the 1970s, payday companies have an acronym, ALICE, for their customers: Asset Limited, Income Constrained, Employed.
On my visit to MEM Finance—which last year was taken over by the Dollar Financial Group, a US payday giant—Raj Singh spoke about serving a British demographic that will be here long after the economy picks up. “What is sub-prime anymore?” he asked. “Our customers are earning twenty-odd thousand pounds a year. They are professionals. They have a bank account. They are sub prime all of a sudden because they’re maxed out on their credit card, or the bank has refused their overdraft. [But] that is just how people live now. It’s tough out there. Let’s accept it.”
Short on time, digitally savvy and fighting their own multi-front war with the rising cost of living, what Singh’s customers wanted, he said, were financial products they could largely design themselves. Unlike big banks, which have spent the last generation mass-producing mortgages and savings products (under Fred Goodwin, RBS had a department called “Manufacturing”), companies like MEM were preparing for an individualised future of financial services. As Singh put it: “I don’t like A, B or C. I want Z.” Accustomed to the flexibility, and cost, of payday lending, this is how his customers, now in their twenties, might one day expect to borrow for a house, or car. “Everything is going to be tailored, going into the future,” said Singh. “And that means you need data at your fingertips every minute of every day. And that is what we do, we live and die by our data. We are ahead of the game.”
At his most evangelical, Singh sounded like someone running a peer-to-peer lending platform. “P2P” companies are the smallest units in the non-banking insurgency—they will lend just £150m in the UK this year—but they have its biggest idea. They use the internet to match people who want to save with people or businesses who want to borrow. Standing on the shoulders of eBay and Betfair, the betting matchmaker, P2P companies are online markets. They check the credit rating of those who want to borrow; spread lenders’ money across hundreds of loans to reduce the risk of non-repayment; and chase bad debts, taking a small fee for their services. “At present, these companies are tiny,” said Andrew Haldane, the Bank of England’s executive director for financial stability, in a speech in June. “But so, a decade and a half ago, was Google… The banking middle men may in time become the surplus links in the chain.”
If payday lenders like talking about quick loans to fix your car, people at peer-to-peer platforms prefer subjects like Carlota Perez’s theory of technological revolutions. “Schumpeter’s waves of creative destruction?” said Giles Andrews, who runs Zopa, the UK’s largest P2P platform. “She took that to the next level.”
We were talking in Zopa’s offices, just north of Soho, in London. The company was set up in 2005 by a group of emigrés from Egg, the online bank of the late 1990s. (Andrews, whose background is in selling cars, did the initial fundraising.) The idea was to create an online bond market for personal loans. For three years, Zopa struggled to attract customers. Trusting strangers online to sell you a t-shirt is one thing; trusting them to repay £7000 in £215 monthly instalments over three years is something else. But the banking crisis has altered our sense of trust. The first wave of new Zopa customers in 2008 were savers, interested in the 5 to 8 per cent interest they could earn. Then came the borrowers, either rejected, often just repulsed, by their banks. After matchmaking £25m in loans in its first three years of business, Zopa brokered almost £200m in the three that followed. It will grow another 50 per cent this year. The site has 700,000 members.
Although they are the smallest and most esoteric players in the non-bank uprising (they are, for now, unregulated), peer-to-peer platforms somehow manage to convey the greatest threat to our idea of what our banks might be. They have certainly enjoyed the most straightforward boost from the atmosphere of dysfunction on the high street. “Was it a surprise that June and July were great months given Mr Diamond and Libor and HSBC?” asked Andrews. “This year, the anti-bank tone has changed somehow in my mind; it is more personal.”
Part of the power of Zopa and its main rival, Ratesetter, is that they compete directly with established lenders. Unlike payday companies, which essentially try to sell new kinds of loans, and credit unions, which are figuring out how to grow and stay alive at the same time, P2P companies try to take profitable business from banks. The conventional wisdom is that banks start to turn a profit on personal loans of more than £7000. Because they are online, have no deposits, and are set up to process loans as cheaply as possible, P2P companies can beat that. The average Zopa loan is £4800. Andrews, the car man, likes to compare P2P companies to Kwik Fit, which stole the profitable-tyres and exhaust market from traditional garages. Right now P2P companies have around 1 per cent of Britain’s £23bn personal loan market, and are growing, as a sector, at 100 per cent a year. “I believe that peer to peer lending will ultimately—and I don’t know how long it will take, five to ten years—do the majority of unsecured personal lending in this country because it is a better product,” Andrews said.
P2P’s biggest grab, though, is for the lost social purpose of our banks. When I talked to Zopa customers, they all spoke of the new imagined community they had joined. A couple who had borrowed money to buy a new car told me about the online avatars of the 190 people they were now paying back. Janet Carr, a retired trade union representative who lends money on the site, said: “I like the fact that my money is actually going out and helping someone, rather than some huge business or whatever. It might sound a bit naïve but that is what I like about it.”
This is the vacuum, part financial opportunity, part social healing, into which peer to peer entrepreneurs are now pouring. Funding Circle, a site set up to channel loans from individuals into the UK’s small businesses, has brokered £47m in the last two years. Samir Desai, one of its founders, came up with the idea when the private equity firm he was working for was considering buying Northern Rock. He saw close-up the misery of high street banking for small companies. “If ever there was a market that needed to be disrupted it was business loans,” Desai told me. This autumn, Funding Circle is expected to become one of the main beneficiaries of the government’s decision to invest £100m through alternative lenders, including P2P platforms, into small businesses. If it comes off, the Department of Business will become just another—albeit massive—lender on the website, contributing a small proportion of every loan, earning interest like you or me.
The government was persuaded, in part, to dip its toe into peer-to-peer lending by a taskforce of financial industry grandees, led by Tim Breedon, the chief executive of Legal and General, which reported in the spring. Their recommendation was a sign that P2P was not just a beautiful theory. “These peer-to-peer models have got beyond the flakey, they’re-never-going-to-fly stage. There is now some very smart money and some very smart executives committed to making them work,” Charles Roxburgh, a McKinsey director and member of the taskforce, told me. “You would expect them to be passionately committed and believe they are going to take over the world. You would also expect the incumbents to say ‘No. It’s always going to be a sideline.’ It is very hard to predict quite which of those is correct.” However, if peer to peer does prove to have mainstream appeal—particularly in establishing a sense of social benefit between lenders and borrowers—Roxburgh said he could see no reason for banks not to build platforms themselves. “I don’t think it is anti-bank in any way.”
For now, though, P2P sites enjoy their rebel status. On the last stop of my tour, seeking out ever more daring non-banks, I ended up in Shepherd’s Bush, in west London. On the second floor of a tatty office building containing a language school and overlooking a hand car wash, I came across the office of Abundance, another lending platform, this time enabling savers to invest in renewable energy developments. Abundance is the brainchild of Bruce Davis, another Egg exile, who helped Zopa develop its brand. The idea is to use the internet to allow tiny contributions to the building and owning of infrastructure—from wind farms to, one day, roads and schools. The site allows individuals to chip in to community-scale green energy projects—starting at £5 a go—and take a cut of the revenue they generate over the next 20 years. Davis calls it “democratic finance.” Up and running since July, Abundance has 1000 members and a wind turbine in the Forest of Dean. It is regulated by the FSA.
Davis is an anthropologist by trade. He was on the phone when I walked in, talking a new member around the website. Before working for Zopa and setting up Abundance, Davis spent years studying people’s behaviour inside high street banks: how the confident became shy, how the otherwise sceptical never questioned that these institutions are the only place to store our wealth. “It is only in the last 100 years that we have allowed private banks to be the way that we think about money and the way that we deal with money” he said. “Banks like to own that whole relationship, which is a bit like saying, ‘Let’s just give BT ownership of the internet.’” Davis paused. “What democratic finance is is that you take control of money by taking decisions about where money goes.”
Then Davis started telling me about Abundance, the intricacy of its debentures, webcams and feed-in tariffs. But I realised that the single tenet connecting everything that he said—and which connected Zopa and rest of the peer to movement—was that the most hopeful consequence of the great failure of our banks is not that they will be swept away. Nor that they will be reformed. But that we will all, in time, become banks ourselves.