Swedroe: Alt Lending Has Many Benefits

August 21, 2017

The current—and almost decade-long—period of extremely low interest rates led many investors, especially those relying on a cash flow approach to investing, to seek alternatives to safe fixed-income investments.

Unfortunately—many such strategies, such as investing in dividend-paying stocks and high-yielding bonds—expose investors to dramatically higher levels of risk, especially left tail risk. Compounding the problem is that this greater risk tends to show up at exactly the wrong time—when equities are doing poorly.

Fortunately, over the past several years, we have witnessed a fundamental shift in the fixed-income landscape, one that provides an attractive alternative to investors who can accept the risks associated with illiquidity.

Fintech/Social Media Transforming Landscape

Banks have long been central to the creation of credit, which is driven by their ability to take in low-cost deposits and loan out money at higher rates.

While nonbank loan channels have always existed parallel to traditional banking, these channels historically were small niches in the overall economy. However, a new breed of lender has emerged to become a significant presence in the market. Initially, they were known as “peer-to-peer lenders” or “marketplace lenders.”

Growth in this space hit an inflection point after the 2008-2009 financial crisis. It was propelled by a severe contraction in bank lending, acceleration in the availability of financial services online and an increasing mistrust of, and dislike for, traditional banks.

'Alternative' Lenders

Today these platforms are broadly recognized as “alternative lenders.” These technology-based lending businesses are disrupting the lending markets and have taken significant market share from traditional banks.

Because alternative lenders are not burdened with the substantial infrastructure costs of traditional banks (they don’t have physical branches) or the same level of regulatory oversight (banks are typically regulated by the full spectrum of state bank examiners, the FDIC, the SEC, the Federal Reserve and consumer credit agencies), they are able to offer loans at significantly lower rates.

It’s important to note that, while interest rates have fallen dramatically since 2008, the average revolving credit card rate has actually risen. Alternative lenders have been able to leverage their superior operating efficiency to offer more attractive pricing to consumer and small business borrowers while also delivering a superior service experience.

 

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