The sharing economy is older than smartphone apps. The modern financial system may be the first example to have evolved. Rather than sharing capital assets such as cars or spare bedrooms, people shared their liquid capital — they lent money to each other that they didn’t need to use right away. But recent regulations threaten to kill off the original killer app.
Historically, access to capital had been limited to those who already possessed it in the form of assets or savings. With the dawn of the modern financial system, the invention of credit meant that those who had capital could share it with those who didn’t. Loans allowed both to benefit.
The classic Jimmy Stewart savings-and-loan model was based on the idea that people pooling their savings and lending out to others to buy houses would increase the capital base, making everyone involved wealthier. A bank manger could even look at a business plan drawn up by someone with no collateral and choose to make a loan based on the plan’s attractiveness. As the financial system evolved, other forms of access to capital developed. It is probably not as widely known as it should be that Sergey Brin founded Google by maxing out his credit cards.
Lending entails risk to the original providers of capital, and access to capital does not guarantee success. But all else being equal, the greater the accessible capital base, the wealthier those who have access to it will become.
Since the most recent financial crisis, many traditional forms of credit have dried up. Despite near-zero interest rates in much of the developed world, Banks are no longer making as many of the speculative loans that started so many businesses in the last century. new regulations from regulators like the Consumer Financial Protection Bureau (CFPB) (and similar bodies in other countries) have severely restricted the issuance of new mortgages and credit cards. Access to capital is harder to obtain.
Three forms of deregulation would improve matters:
- A more liberal approach to the chartering of new banks. Studies have shown that new banks are more likely to lend to small businesses and startups. In the United States, Congress should place firm time limits on regulators for the approval of new banks and it should end outdated regulations that separate banks and holding companies, allowing retailers like Walmart to open banks (Walmart’s British counterpart Tesco runs a successful bank in the United Kingdom).
- Greater accountability for financial regulators such as the CFPB. The CFPB is insulated from accountability by a number of structural problems, which need to be addressed. Greater accountability will make the agency less likely to be captured by an ideological aversion to lending. Similar arguments apply to the international financial regulatory framework, which operates at two degrees of separation from public accountability, and which has led to regulatory harmonization that may be self-defeating.
- An end to the zero-interest-rate policy of central banks such as the Federal Reserve, which has led to a malinvestment in already existing large firms via the stock market rather than saving via bank deposits, which can in turn be used to provide access to capital via loans. In addition, capital requirements have led to banks unnecessarily holding on to funds that could be used for investment.
- Each of these policies could make it easier to lend and borrow. Taken together, these three approaches form a deregulatory manifesto for greater access to capital.
The market, however, has already found new ways to share capital between investors and those who require it. In particular, two new forms of access to capital have developed in recent years:
- Crowdfunding: This form of financing allows those with good ideas or talents to find multiple backers willing to help them flourish. Various online platforms have developed different models of funding. Patreon, for example, allows patronage of an individual by many small-dollar donors. Indiegogo specializes in helping investors back a project in return for tiered rewards (the greater the donation, the bigger the reward). Kickstarter specializes in letting people fund projects through a preorder model, where those who fund a product’s development are the first to receive it, usually at a discounted price, when it comes to market. A fourth model, equity crowdfunding, allows companies to offer real equity investments with the benefits of ownership. This model has been restricted by securities law in countries like the United States, but recent deregulation has led to the beginnings of a market (for more information, see John Berlau, “A Declaration of Crowdfunding Independence,” from the Competitive Enterprise Institute).
- Peer-to-Peer Lending: Another innovative form of financing includes companies such as Prosper and Lending Club that match investors with people who want to start a business, take out a loan for home repair, or pay off debts, to give just a few examples. Individuals borrow funds at an interest rate appropriate for their risk. In the United States, these services are again significantly restricted by securities law, which has impeded the development of the market (other countries, like the United Kingdom, are less restrictive). Deregulation of securities law to facilitate peer-to-peer lending could significantly increase the size of this market and disintermediate banks, thereby mitigating the effects of the regulatory restrictions described earlier.
The use of cryptocurrencies and the blockchain can further develop both approaches, obviating some of the regulatory inefficiencies. Moreover, with an ongoing debate among libertarians over the morality or otherwise of fractional-reserve banking, these innovations could well square that particular circle.
Regulators should allow these markets to develop naturally, just as the banking system evolved over time, rather than taking a precautionary approach. Doing so would increase the number of people able to access capital, thereby alleviating poverty significantly. Jimmy Stewart would no doubt approve.