Banks like Westpac Banking Corp (ASX: WBC), Commonwealth Bank of Australia (ASX: CBA), Australia and New Zealand Banking Group (ASX: ANZ) and the National Australia Bank Ltd (ASX: NAB) earn a big chunk of their money by providing loans to customers at a rate higher than what they pay to depositors.
For example ANZ pays 2.4% annual interest on its one-year term deposit, and charges 13.95% annual interest on its personal loan.
The difference between the two is 11.55% which is what ANZ keeps to fund its operations and turn a profit. In bank speak, this is also known as the “net interest spread” or just “spread”.
The spread for the big banks is higher than it is for direct banks like ING Direct, RaboBank, ME or UBank (run by NAB), which are internet based and don’t have a bricks-and-mortar branch infrastructure.
Direct banks usually offer slightly higher interest rates on deposit accounts, lower loan costs, and reduced fees because they do away with the costs and inefficiencies (and arguably some of the service) of the traditional banks.
For example, the direct bank ME pays 2.85% annual interest on its term deposit, and charges 12.49% annual interest on its personal loan, making for a spread of 9.64%. Compare this to ANZ’s spread of 11.55% and you’ll note that ME’s more bare bones set up allows it to better cater to the more cost-conscious customers.
The new kids on the block are P2P lenders like DirectMoney, RateSetter and SocietyOne.
These fintechs connect investors and borrowers via the internet, using algorithms that assess the credit worthiness of borrowers and risk appetite of investors before matching up both parties.
Based on these criteria, individual investors’ funds are fractionalised into small chunks that then get pooled together with other investors’ funds to make up the loan amounts required by the borrowers.
Another difference between P2P lending platforms and banks is that P2P loans are typically unsecured and as loans are given to individuals and small companies, the risk of default or late repayment is higher.
The low-cost infrastructure, riskier loan book, and default risk mean that an investor should get a better return than what they would get from their bank’s term deposit. A borrower would also pay less interest than what they typically would for a personal loan from their bank.
For example, the P2P lender DirectMoney Ltd (ASX: DM1) pays the investor around a 7.50% annual return for their personal loan fund, and charges the borrower around 9.50% annual interest on their personal loan. The spread is just 2.0% – a fraction of the banks with ANZ at 11.55% and ME at 9.64%.
Since the P2P lenders can finance their operations on a small spread, they can offer better interest rates to borrowers and better returns to potential investors who understand the risks of unsecured lending.
|Lender (Personal Loan)||13.95%||12.49%||9.5%|
|Borrower (Term Deposit)||2.4%||2.85%||7.5%|
|Net interest spread||11.55%||9.64%||2.0%|
* All rate as of 2/6/17
As a business model, P2P lending is still relatively young in Australia but it is growing rapidly: according to Morgan Stanley it will reach $22bn by 2020, taking a 6% slice of the lending market.
However, although P2P lending is on the rise, I personally don’t feel that there is any reason to worry that the banks’ traditional lending model may disappear anytime soon.
In fact, banks and other companies are looking for ways to get involved in the P2P space themselves. For example, P2P lender SocietyOne is backed by Westpac via the Reinventure venture capital fund.
By entering the P2P lending space, the banks will be hedged against any potential unraveling of traditional consumer lending practices.
On the other hand, the banks’ involvement is likely to accelerate the growth of the P2P lending market as well. While joining the P2P lending space may seem like a double-edged sword for CBA, Westpac, ANZ and NAB, I am positive that these banks will evolve and adapt to the P2P lending reality.
The new bank levy caused a price drop in the banking sector and yields are now creeping up over 9% at the NAB, which is getting close to the interest on offer from P2P lending, but possibly with lower risk.
If you asked me today to choose between putting my money into P2P lending or investing it into the big banks, I’d probably go with the banks.
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Motley Fool contributor Jens Omenzetter owns shares in ANZ Bank, National Australia Bank & Westpac Bank. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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