Where does your money sleep at night?
As the financial sector has adapted to a digital environment, innovation in the technology that surrounds it has continued to burgeon…
As the financial sector has adapted to a digital environment, innovation in the technology that surrounds it has continued to burgeon. Peer-to-peer lending, robo-advisors, mobile wallets, alongside many other digital fronts, are changing the way we deal with money. Still, there is more room for change.
The Consequences of Banking
An important economic factor to understand when thinking about banking is the velocity of money. This is the concept that describes the rate at which an individual dollar will exchange hands between consumers, retailers, and banks. VoM helps investors gauge the strength of an economy and is a key input in determining an economy’s inflation calculation. Banks are the largest gatekeepers of funds in any economy. Where they choose to lend money greatly impacts the micro-economies surrounding the borrowers and sets off where the measured VoM will originate. In the case of regional banks, lenders can create enormous value for a community by choosing to lend to local businesses. If a bank makes the choice to invest locally, it can create a domino effect of consumption, indirectly boosting other local business.
The SBA notes that there is a clear relationship between strong local investment and the long-term success of local economies. For example, if an established bank is able to lend funds to a new bakery in your neighborhood while the bakery is in the infancy of its business cycle, the new business is 35% more likely to be successful. Credit is a powerful tool. As large banks have better diversification of risk, they can afford to offer lower rates to small business owners. The bakery will be able to use the early funding to employ community members, pay local licensing fees and taxes, create foot-traffic, and even increase local property values. When the loans are paid off and the business is self-sustaining, it will continue to generate a net positive value for the community. These residual effects of loan-choice can have enormous long term implications for the success of a city. Unfortunately, the most established banks in the country have continued to pull away from small business lending. Together, 10 of the largest U.S. banks issuing small loans to business lent $44.7 billion in 2014, down 38% from a peak of $72.5 billion in 2006, according to an analysis of the banks’ federal regulatory filings. 27% of businesses surveyed by the National Small Business Association claimed that they weren’t able to receive the funding they needed. For those 1-in-4 businesses, the most frequent primary impact that a lack of funding had was preventing them from growing their business. A disproportionate amount of this 25% was comprised of women- and minority-owned businesses. These systemic failures have forced small businesses too look towards other lending options. Often these alternate lenders provide funds at higher rates, cutting into earnings, and leaving less money (reduced VoM) to benefit the community.
While Dodd-Frank reforms in 2010 forced bank holding companies to be more transparent about risk, leverage, and credit, there continues to be a need for greater transparency. Banks have a social responsibility to not only protect the funds of investors, but to recognize their potential to impact small business. The triple bottom line approach to business accounts for fiscal, social, and environmental impact to be considered when determining the ‘quality of quarterly returns’. Unfortunately, as the system stands, banks have little incentive to keep small businesses in mind. Regardless of the credit quality of a small firm and their ability to repay a loan, the cost and time required in engendering the underwriting process can outweigh the marginal benefit to the bank’s balance sheet.
Because banks have so little incentive to invest in a socially responsible manner, it is on the investors to voice their concerns through their actions. If consumers opened their saving accounts dependent on where banks would lend that money, our society could greatly reshape local business and drive large banks to invest socially. Currently, the driving forces deciding where an individual chooses to bank are proximity of ATMs and word of mouth. Interest rates are marginal and often smaller banks offer competitive returns.
This past year, I’ve had the privilege of undertaking the role of Student Director at EntreCORPS, a student-run consultancy based on the University of Illinois Champaign-Urbana campus. One of our clients, Mighty Deposits, has spent a great deal of time brainstorming how to tackle this social-savings problem. In the next year, Mighty is looking to role out their beta product and engage with consumers and organizations alike. By providing a platform for users to see where their funds are being lent by a bank and identifying which social causes the bank supports, they look to create a new dimension for consumers to decide where they save. Most often, individuals are content to see their funds sit in a savings account generating pennies on a diminutive interest rate, without thinking twice about how that money is being used. Instead, if those funds were placed in a bank that supported minority-owned business- at no cost to the saver- wouldn’t it always be the better alternative? The success of platforms like Mighty is dependent on savers and investors making this conscious change. It is dependent on us asking the question- “where does our money sleep at night?”. Activists and passive philanthropists alike can put their money to work. With this platform, opening a savings account can mean standing for a cause and supporting your community.
Sources
https://www.sba.gov/category/advocacy-navigation-structure/research-and-statistics
http://www.investopedia.com/articles/financial-advisors/091615/rise-socially-responsible-lending.asp