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How to Encourage Bank Customers to Take ‘Good’ Risks
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With consumers and businesses seeming more risk-averse than ever, there is an opportunity for financial services providers to rethink what it means to make bets in line with their customers’ financial well-being.
In general, Americans are taking fewer “good” risks today than they were 20 or 30 years ago. Over the same time period, real household incomes are down and personal debt is up. As a result, both the economy at large and banks, in particular, face constrained growth prospects.
Good risks include starting a business, proactively changing jobs, buying a house, going to college and investing in the stock market. They are risks that create wealth when the bet pays off. But several indicators suggest we are pulling back on this kind of risk-taking.
Americans started 3% fewer small businesses in 2013 than in 1977, even though the population has increased by nearly 100 million people over the same period. Even the rate at which we search online for topics related to startups has declined by half since 2004.
We are quitting our jobs for better opportunities less frequently. In late 2001, more than 27% of Americans quit their jobs each year in pursuit of another — a level we have not seen since. At its worst point in 2010, the annual number fell to around 15%. Even today, six years later, we are only back near 25%, according to the Bureau of Labor Statistics.
More of us are also opting to rent rather than buy homes — the homeownership rate is lower today (63.7%) than it was in 1995 (65.1%). And only 55% of us are invested in the stock market, down from 67% in 2002. Even the number of Americans pursuing higher education has declined very slightly over the last three years, according to the National Student Clearinghouse Research Center.
One of the best ways to induce more good risk-taking is to expand access to credit. There is undoubtedly a need for that in some parts of the economy. However, Americans have taken on more debt even as we have taken fewer good risks, making it harder to view expanded lending as a fix-all for good risk-taking. Real household debt is up 12% since 2003, while real income is down 2.5% over the same period.
In more volatile times, businesses often prefer the flexibility of equity to the fixed repayment schedules of debt. This is exactly what the largest companies have done. The debt-to-equity ratio of the companies that make up the S&P 500 is at its lowest level since 1988.
A small number of products on the edges of the financial system point the way toward more equity and equity-like financing for good risk-taking. For example, to help small businesses grow, Fundable and CircleUp have introduced online equity crowdfunding markets.
Meanwhile, shared-equity mortgages involve third-party investors making minority equity investments in private residences. When a home sells, investors get their share of the return. The family that owns a majority of the home is responsible for upkeep, and covers their majority of the financing with a more traditional mortgage. Today, this kind of structure is most common when parents want to help children buy their first home. And a start-up called Point now offers to buy a minority stake in Americans’ homes, as an alternative to home equity lines.
Even products where consumers are paying down principal and interest can be tailored to be more equity-like, in line with the outcomes they enable. Approximately 4.5 million federal student loans now tie repayment to income. The Wall Street Journal recently credited these loan structures with a drop in student loan defaults. Private sector expansion of similar products to mid-career adults would make it easier to take on the risk of attaining new skills with less downside if the investment does not pay off. One key challenge would be to determine what constitutes an appropriate share of upside for “investors” when the new skills do pay off.
In the current environment, it is very difficult for banks to take these kinds of products head-on. The economic model and risk-management tools for equity and equity-like structures may look more like a cross between marketplace lending and product structures that are more familiar to investment banks than to retail banks and their regulators.
A more reasonable next step is experimentation via nonbank partners, replicating the fintech partnerships banks have already developed with online lenders and digital payments companies.
The investments that banks are already making in blockchain will also help. The record-keeping requirements are likely to be much more complex for equity and equity-like products than traditional debt structures. Blockchain will make managing this complexity lower-cost, more secure and something that can more easily be securitized to facilitate liquidity.
Beyond the societal benefit of figuring out these new products, there is a commercial need. McKinsey recently predicted that 20% to 60% of banks’ earnings are at risk by 2025 due to price pressure from lower-cost fintech alternatives to today’s mainstream consumer-banking products. That means more fundamental product innovation is required if banks are to find new sources of earnings.
In that context, technology-enabled disruptors can build new businesses, banks can scale ideas that would be very hard to develop entirely in-house, policymakers can address one of the core issues at the heart of our economy and families would be much better off.
Robert Schiff is a vice president and general manager at Medallia, the global SaaS-based customer experience technology company. The views expressed are his own.
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How to Encourage Bank Customers to Take 'Good' Risks
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