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This week has seen a range of reflections on the tenth anniversary of the financial crisis. The image of customers queuing to withdraw cash from a UK bank was – and remains – a powerful reminder of how fragile established institutions can become.
In the decade since, what have we learned? Is our financial system now more stable than it was then? As a nation, have we become more or less engaged in making our money do more for us through investments and savings?
The answers to those questions are, perhaps unsurprisingly, complex. As such, we’ll focus on two specific issues related to them, which should take us on somewhat of a journey to answering them.
Importantly, these two issues demonstrate successful outcomes, achieved firstly through regulatory intervention and secondly through market-driven innovation. Regulatory intervention delivered more robust banks through recapitalisation. Market-driven innovation reconnected lenders and investors with borrowers and businesses. Both of these developments are now explained in detail.
1. Recapitalisation of the banks
The first is the availability of capital. When Northern Rock ran aground, many commentators immediately proffered two explanations - either that Northern Rock had:
- lent too readily to what US analysts termed the sub-prime mortgage market; people who were likely to have difficulty making good on their mortgage repayments.
And/or
- been too willing to issue mortgages in excess of a property’s value, which left the bank exposed to unsecured debt in the event that the borrower defaulted, even if the property itself had held its value.
Whilst these two explanations may have contributed to the difficulties that led to Northern Rock being taken into public ownership, they were not the principal cause.
The principal cause was that Northern Rock, like most banks, had become accustomed to borrowing through wholesale markets to fund their lending. This represented a departure from the more traditional model of using cash deposits to fund lending.
As technology advanced, borrowing became more and more short-term. Theoretically, this is fine - until someone turns off the taps, which is exactly what happened and produced the scenario that was to be coined the 'credit crunch'.
Northern Rock was left in a situation where its customers were not due to repay mortgages for years - even decades - into the future, but the cash that Northern Rock had borrowed to fund this lending was due for immediate repayment. The UK Government was left with little option but to step in and honour Northern Rock’s creditors.
Following the crash, the UK Government introduced a range of measures to both support and require banks to reduce their exposure to the threat that caused Northern Rock such a problem.
This can broadly be termed recapitalisation - by holding greater deposits, banks’ exposure to crises of confidence and the consequent absence of capital is decisively reduced.
Although this recapitalisation has strengthened the position of the UK banks, the legacy of mistrust following the financial crisis has cast a long shadow over many.
This experience, combined with technological innovation and shifting consumer preferences, has created an opportunity for challengers to the big five banks (HSBC, Barclays, Lloyds, RBS, and Santander) to capture some of the UK retail banking market that had previously been considered impenetrable. Challenger banks, such as Atom Bank, are forging ahead; driven by individual advocates who are simultaneously investors and customers.
2. Unravelling the complexity of the financial industry
The financial services sector has consistently proved itself one of the most innovative. Whilst many financial innovations have benefitted customers, some have destabilised the financial system.
This was the case in the global crisis that unravelled later in 2007 and into 2008: financial products had emerged under the regulatory radar and were being traded recklessly. Collateralized Debt Obligations became the unwilling poster child for this phenomenon.
Unlike recapitalisation, specific policy responses were more difficult to identify and consequences more tricky to attribute.
One fundamental challenge faced by financial services was a need to reconnect with the core principles of saving, investing, borrowing, and lending. Alternative finance contributed much in pursuit of this:
- Peer-to-peer (P2P) lending platforms gave people the opportunity to lend directly to other people or to businesses; a straightforward transaction facilitated by increasingly sophisticated technology.
- Similarly, equity co-investment has emerged as a popular method of investing directly in ambitious early-stage businesses. The principle process of enabling everyday retail investors to invest alongside experienced and professional investors ensures the former acquire the confidence needed to acquire a diversified portfolio. Before 2007, this simply wasn't something that existed.
In both examples, removing some of the intermediate stages serves both to offer a superior return for lenders/investors and to remove the opportunity for capital to find its way into complex products before it reaches its intended recipient.
Future outlook
One of Growth Capital Ventures’ central ambitions is to make investing more accessible. We want to keep this as simple as possible.
We currently host equity investment opportunities on our GrowthFunders platform in which you can invest from as little as £100. The process can be completed in minutes, from first registration to selecting your opportunity and the amount you’d like to invest.
A key achievement has been enabling everyday retail investors to assemble diversified investment portfolios at relatively low cost.
With such a low entry point, you can make five investments in five very different businesses for a total cost of just £500. And that £500 is an actual cost - it doesn't take into account the generous tax reliefs offered by investing into SEIS and EIS opportunities (just two of the numerous tax efficient investment options currently open to UK investors).
With it clear UK investors are embracing this simplicity, few would argue the financial road ahead is still a turbulent one, but this confidence in investing is undoubtedly a positive sign for the future of our economy.
Northern Rock image courtesy of Lee Jordan.
