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Bim Afolami on the changing nature of finance in the digital economy

What did the financial crisis demonstrate about modern, big and globalised finance?Although we appreciate that the answer as to who ‘caused’ the financial crisis is complex, the crisis has shown that much recent financial innovation has failed to create (or even enhance) enough economic value in the real economy. In the future, the key question is: how should finance help serve the new economy and correspondingly re-legitimise its place in our market economy?

Most fundamentally, finance needs to remember that it needs to be part of society, not apart from it. Financial firms must adapt their models to better serve both (i) the new workforce, which is much more likely to be self-employed and (ii) new business, which is likely to be tech–based, more mobile, and much smaller.

One in seven of the British workforce is self-employed, and 40% of new jobs over the past four years came from self-employment. For young people, these figures are even higher. Well over 50% of new jobs are created by Small and Medium Enterprises (SMEs). If banks are to do a better job of being part of society, and not apart from it, they need to be serving this SME community much more effectively. If they do not, the vacuum will be filled by alternative financial providers.

The modern world presents many problems. Alas, not all of them can be solved by finance! However, some can be made just a bit easier. For example, with rising house prices let’s see banks think more creatively about offering alternative ownership models so that more people can own a home of their own. Why shouldn’t banks give people the opportunity to buy 50% (rather than 100%) of a new home (50% owned by the individual, 50% owned by the bank), which could really help first time buyers? Governments (local and central) have certain versions of this – why not banks?

One principal way in which SMEs (and especially newer SMEs) are currently poorly served is that they don’t have enough access to capital. The model used by banks works very well if you are an established business. They work adequately if you are a new business entering a market that is well established and clearly understood by the bank’s managers. However, if you are a dynamic small business, perhaps internet based or reliant on technology, banks rarely deal with you because you don’t fit their traditional models. This can be changed. Banks can be more flexible and set up teams who understand the new growing businesses that are providing so much growth in the modern economy, and also attracting many of our most gifted young people.

Why can’t banks ignore these trends and go on as before? Banks are being increasingly cut out of the growing new markets for finance, and alternative financial providers are going to fill the gaps in provision. Technology has fundamentally changed the business model of most industries – finance is not immune. The rise of cheap physical computing power and communications has allowed peer-to-peer lending to emerge as a major source of finance for small start-ups.

Take one example: Seedrs is an equity crowdfunding platform for investing in start-ups and later-stage businesses, which allows users to invest as little as £10 into the businesses they choose and lets earlystage start-ups and more established businesses raise investment from friends, family, customers, ‘angels’ and other independent investors in exchange for equity in the business. It grows at 15% per month, and has funded 110 deals in 2014 alone. It is plausible that larger businesses might start using similar methods to raise finance from both the UK and abroad. This will not only reduce the long term income of banks from businesses, but it will further divorce banks from the very people that they are meant to serve.

Banks also need to allow their very capable people to think innovatively about how to serve the new British workforce and keep connected to the revolution in British business, and not just leave new business entirely to these new platforms. Where government regulation does not allow them to do either they should call out and apply pressure to have regulations changed – if they can show that their innovation will benefit the real economy. Otherwise, they will slowly become unloved, decaying relics of our economic system, not part of society but apart from it.

Bim Afolami works for a large international bank and was the Conservative Party PPC for Lewisham Deptford at the last General Election