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We should pay heed to the new faces in finance

June 1, 2013 | The Financial Times p.16| by John Authers.

For five years now, we have dwelled on the problems of the old finance. The efforts of financiers, politicians and regulators have been geared to fixing them. But it is possible to discern the shape of a new finance emerging , largely without the help of governments - or existing financiers.

Financial innovation has a bad name, and with good reason. Precious little of it is happening in the big institutions that sparked the crash of 2008. Instead, new companies are using new technology to look at each part of the service that financial groups offer, and offer it in a new way.

The trend is clear, and this week gained the imprimatur of a two-day conference, called "The Future of Finance", at the University of Oxford. The new finance is arriving; what can it achieve?

Payments can now be made directly via a mobile phone, without involving a bank. A group called M-Pesa has spurred commerce in east Africa, and raised the tantalising prospect that payment systems - which can never be allowed to fail - could be separated from the bloated banks that control them.

Beyond the payment system, loans can now be crowd-sourced, even across borders, as peer-to-peer networks offer entrepreneurs the chance to raise money without needing to approach venture capitalists, or banks. Kickstarter, a New York-based network to raise finance for art projects, has directed $636m to 42,000 projects since 2009 - numbers that are large enough to show its viability.

The concept is springing up all over. The UK Crowd Funding Association was launched with 12 members this year; Singapore boasts a company called Crowdonomic.

Business models are also proliferating. All Street, a London-based, non-profit group that aims to support alternative finance, lists separate peer-to-peer finance groups for equity, rewards, donations, trade finance, and personal and company loans.

When it comes to alternative currencies, models range from community-based "time banking" - where one hour of community help entitles you to one hour of help from someone else - to virtual currencies, community currencies - on offer from places as varied as Bristol in England and Ithaca, New York - and currencies used in online games.

In the model of finance that was discredited in 2008, different services once offered by banks were plucked away by capital markets. Lending officers ceded their pricing power to traders in areas such as securitised mortgages, money market funds and commercial paper.

Financial institutions themselves grew ever bigger, as capital markets operations benefit from economies of scale. But now the traders are under threat from the crowd; the aim is to democratise finance, using the same technology that allowed social networks to grow.

All of this is emerging, independently, across the globe, even as old finance licks its wounds.

But can the invisible hand of the market really be trusted to design a new system? A libel can easily and swiftly be repeated to gain the currency of truth on Twitter, for example. Do we really want to adopt the same model for finance? Or should elected governments not at least attempt to nudge it in the right direction?

A second concern is whether an atomised financial system is really desirable. Many (myself included) felt that a critical problem with the ancien regime was the lack of a role for judgment or trust. The lending officers who approved "subprime" loans to people who could not repay them were not on the hook for the risk of a default - instead, as the mortgages were packaged, securitised and sold to investors, that risk was sold on and dispersed.

Relying on the wisdom of crowds to raise finance runs the risk that the critical elements of trust and judgment will again be missing, and borrowers never meet their creditors face to face.

We do not want a new model in which financiers continue to think of their job merely as a series of transactions, rather than as a commitment to the welfare of their clients.

So governments need to keep an eye out. But for now, their role is clear: to reduce barriers to entry - dauntingly high when it comes to obtaining a bank licence, for instance - to allow for experiments.

Experimenting in our existing system would be too dangerous, because the institutions that dominate it are too big to fail. The risk of failure is too severe to countenance. But that is not true of the emerging new financial bodies.

While institutions remain small, there need be no barriers to exit. If they cannot persuade customers to trust them with their money, then they should be allowed to fail.

Governments should step back, see what works, and stamp out whatever does not. Anyone looking for an investment opportunity should do the same.

And all of us should explore new options when we make payments, take out a loan, or seek to invest.

By John Authers