Will Technology Render Fractional-Reserve Banks Obsolete?
By Joseph T. Salerno
Imagine that you need a cash loan to tide you over to your next paycheck, but banks cannot or will not lend to you. So you stop at a machine that looks very much like an ATM. You scan your passport photo, pose for a photograph, enter your cell phone number, and punch in the sum of money that you would like to borrow. Within 15 minutes you receive a text message indicating that your loan application has been approved and directing you to return to the machine and withdraw your cash. This is not fanciful speculation about the future of finance but a reality in Moscow, where 20 such “loan ATMs” are being tested in train stations and shopping malls. The machines belong to SMS Finance (an affiliate of 4finance Holding), which is owned by parapalegic Russian billionaire Oleg Boyko. Boyko became wealthy operating slot machine casinos in Russia before they were banned in 2009.
The machines dispense up to 15,000 rubles ($241) per loan, which must be repaid in 20 days or less– with an interest rate of 2% per day or 730% on an annualized basis. When the loan comes due borrowers may repay it at a local bank, electronics store, online, or using a digital payments system. While the default rate on these micro-loans is 10%, 55% of overdue debt is eventually repaid. The loan ATMs will be tested in Poland and Spain next.
This is one of several recent examples of innovations in technology and finance being creatively married by entrepreneurs to provide financial intermediation outside of the politically privileged and governmentally insured fractional-reserve banks.
Yet another exciting example of nonbank financial intermediation is represented by small-business lender OnDeck Capital. OnDeck makes loans in the amounts of $5,000 to $240,000, and uses algorithms rather than loan officers to determine borrower creditworthiness. Prospective borrowers apply online, and OnDeck makes loan decisions within a few hours. If the loan is approved, the money appears in the borrower’s account the next day–versus two weeks later for banks. The default rate on OnDeck’s loan portfolio is 5%, about comparable to that of bank loans. The traditional way for small businesses to acquire needed capital is via merchant cash advances on their future credit card receipts. These advances bear a hefty annualized interest rate of 70% to 120% or more. OnDeck lends to restaurants, nail salons, auto-body shops, etc. typically at an interest rate of 60 percent or less per annum. In December 2014, OnDeck’s I.P.O. raised $200 million at a price $2.00 per share above the forecast range giving the firm a total valuation of $1.3 billion.
Since OnDeck acquires its funds from selling equity and drawing on lines of credit with hedge funds and banks, it is immune to a dreaded “bank run” that is a continual threat to institutions which lend depositor funds and, in the process, create money– institutions otherwise known as fractional reserve banks.
Addendum: For the general case that technology has “leap-frogged the banking sector, rendering it as obsolete as buggy whips,” see the thoughtful piece by Charles Hughes-Smith here.