THE INEVITABLE evolution of the peer-to-peer finance industry will be a “red flashing light” for regulators, City grandee Lord Turner has warned.
The former Financial Services Authority chairman said that the sector will probably move towards complex entities such as structured investment vehicles (SIVs), which would be “concerning” for the authorities.
“[P2P lenders] are doing good credit analysis, they’re dividing it into tiers, they’re offering that to investors. I think they’re a useful part of the system,” he told Peer-to-Peer Finance News in an exclusive interview after his speech at the LendIt Europe conference last month.
“I think what will worry regulators is if the thing becomes more complex over time. If people start taking more of these packages of loans, turn them into credit securities, sell them down to people who don’t really understand what they are, or sell them into things like SIVs – I mean a real flashing red light will be if we see a thing like a SIV.
“What was a SIV? A SIV was a special purpose vehicle that took a whole load of credit securities and then said, against these credit securities I’m going to have some medium-term investors and then issue short-term rollover debt. And I’m going to achieve maturity transformation because I’ll have some of my debt at 30 days even though the natural tenure of my securities is, say, 20 years.
“That’s concerning. Now I don’t think that’s happening to any significant stage at the moment, but it probably will because what we know is that these financial systems continually mutate and continually evolve and the process of searching for new ways of profit will create new risks.”
In his speech at the conference, Turner qualified his infamous comment made earlier in the year that P2P lenders could be the source of losses that would “make the bankers look like absolute lending geniuses”.
He said he was talking about individual retail investors doing their own credit analysis, “but in fact individual investor credit assessment now plays only a very minor role in the growing direct lending market”.
He added that P2P lenders’ credit analysis systems were at least as good as those of banks and that “direct lending is likely to become a stable, significant and useful part of our total credit supply system”.
The economist, who was previously chairman of the Pensions Commission, thinks that the financial system is “significantly safer than it was in 2008”, thanks to higher capital and liquidity requirements on banks.
In his most recent book, Between Debt and the Devil: Money, Credit, and Fixing Global Finance, he argues that our addiction to debt is the main danger to the economy.
“I think our biggest risks across the world are too much leverage,” he told P2PFN. “We’re stuck in this period of very low interest rates because of that. I think a lot of work has been done in making the financial system safer.
“At the moment, I’d be far more worried about complex political risk than the financial system itself. I think we are much less likely now, or any time over the next five years, to have a Lehman’s moment than we were in 2008. Beyond five years I do not know as the financial system will evolve in ways, under the pressure of financial innovation, which could produce a set of circumstances that the regulators and the central banks didn’t see coming.
“Right now I think we are more likely to see a dramatic crystallisation of risk developing from an overleveraged real economy, slow growth and the political responses coming from that.”
Turner thinks that easy credit has contributed to the property price bubble in the UK and that the subsequent growth of the buy-to-let (BTL) market has had a detrimental effect for first-time buyers.
“When you have lots of availability of credit at high loan-to-value (LTV) ratios, it tends to push the price of property to a level where people who don’t have help – say from the bank of mum and dad or inheritance – can’t get on to the property ladder at all, whereas people who already have some money can leverage up and can buy more houses with BTL,” he said.
“If credit supply had been more restricted back in the 1990s because of higher capital requirements against mortgage lending or LTV limits, house prices would not have gone up as much and it would be easier for first-time buyers to enter the market.
“Owner occupation keeps going down partly because the BTL market keeps on going up and up and up. And the BTL market is driven by the ease of credit supply, not the restrictions on credit supply.
“I think it was very odd that for a long period of time we allowed BTL investors to have a more favourable tax treatment than owner occupiers. They had tax deductibility of interest and owner occupiers didn’t. The reforms last year meant that BTL investors are now restricted to tax deductibility at the standard rate, but fundamentally I think there shouldn’t be tax deductibility of interest.”