Yielders pioneering Islamic Fintech in the UK

In my previous posts, I discussed how Fintech with a social impact could be a viable business model. Would Financial Services and banking be viable if it got more ethical? Post recession, we have had regulations force good business practices within banks. Decades ago, with products, processes and policies driven by cultural values, Islamic banking has just done that – taken an ethical route to Financial Services. Yet, Islamic banks have struggled to compete due to those constraints. We may have just found an answer to make this system more competitive in Fintech. Yielders, a UK based equity crowdfunding provider, has just attained the first Islamic Banking certification and become the first FinTech firm in the West to do so. Yielders have developed a proposition that looks pretty innovative, pragmatic and competitive in a low yield environment. In the process, they might well have set themselves on a path to pioneer viable Islamic Fintech in the UK and possibly in the West.

Islamic banking in the formal sense has been around for well over 60 years. However, Financial institutions that comply with Sharia laws only manage 1% of assets globally. This has been attributed to some of the principles, which act in ethically regulating the business, hence make Islamic banking less competitive. The key principles are,

  • No Interest (Riba): Sharia compliant banks cannot charge interest on their products. This is because of the principle that the banks can’t charge someone interest because they had access to money that the clients didn’t. And money can’t create money, which will result in rich becoming richer and the poor becoming poorer. Lending can be only against tangible assets.
  • No Uncertainty (Gharar): Institutions have to be transparent to its customers on the products they are being sold. There cannot be an open ended or uncertain contractual relationship between a Sharia compliant institution and its customers. In the west, this is now being enforced, under Conduct based regulations.'...And in this dungeon we incarcerate the lowest of the low - the mis-sellers of P.P.I. schemes!'
  • No Gambling: This is clearly prohibited under Sharia laws. But this is not just about not lending to a casino business (Gambling). Products that are based on making money in an uncertain situation (Speculating) like derivatives (Futures, Forwards, Options etc.,) are also prohibited.

If the whole of the Non-Muslim world had followed the above principles, we wouldn’t have had a credit crunch in 2008. Now, following these principles come with various overheads.

Product Development: Islamic Financial Institutions (IFI) need to be more innovative than their Non-Islamic counterparties to remain competitive. In the UK, there are 5 Islamic banking entities, and only one of them provide products for retail customers, and those products aren’t competitive on returns when compared to high street banks.

Regulation and Standardisation: There is no central body to regulate and support IFIs as we have the FCA in the UK for banks. This ends up in a lack of awareness with the institutions that want to understand this space better. Also, interfacing between Islamic and Non-Islamic Financial Institutions is quite challenging without the standardisation of products and operational processes. Most IFIs self-certify with certain authorities or with a panel of experts in the field.

Liquidity: As a result of the above two points, there is poor liquidity for Islamic banking products, with low volumes and transactions. This is also worsened by inefficient back office processes that are yet to be upgraded to 21st century standards.

Innovation: Islamic banks are still trying to get into digital banking, when this has been well on its way in the West for almost a decade. Most records are still paper based, and information exchange is not automated.

'If there's one thing the British are famous for, it's talking about the banks.'

Yielders leads the way:

Most of the current challenges could be solved by thinking Islamic banking and its products ground up, which is what Yielders have attempted to do. Yielders, an equity crowdfunding provider, led by Irfan Khan proves Fintech could be an answer to most of the above issues. Irfan was born in the UK and has spent 15 years specialising in developing technology solutions within Banking. His passion to bring to light the principles behind Islamic banking, and make them work in a Western context was the driving force behind Yielders. Today Yielders is the only Western FinTech firm that is Sharia compliant.

Over the years, Irfan has seen and understood the challenges that IFIs have had in the UK and wanted to change the landscape. One of the key issues with existing IFIs in the UK has been that, they have only targeted the Muslim community in the country. None of the IFIs in the UK have a non-Muslim name for example. In his opinion, they establish themselves in the west with almost an acceptance that their products wouldn’t be competitive enough for the non-Muslim world, and they would play the “ethical-product” marketing route with their Muslim customers. Irfan has turned this approach on its head by establishing Yielders as a Western financial institution that complies with Sharia principles. This he believes would attract more Western customers who the traditional IFIs haven’t even bothered targeting.

The other fundamental issue with IFIs operating in the west was that they were “shoe-horning” their products to the western markets. Irfan is taking a ground up approach with a Fintech hat on. At Yielders he is able to be more innovative with his products as he has structured them to be compliant with Sharia laws. However, he doesn’t think this is possible in a traditional IFI (yet) that lacks the agility of a Fintech firm. As a result, he is able to offer competitive returns on his products that are currently focused on Real estate, and could soon be extended to ISAs, SIPs etc., Yielders currently offer up to 6% net yield (without leverage) plus capital appreciation. This is a very practical and differentiated proposition for middle class consumers in a low yield environment.

It also became evident during the interview with Irfan that apart from agile product innovation, innovative data sourcing/interfacing is needed to make back office operations more efficient for IFIs to run on a lower cost base. As the operational costs go down, products can be priced more competitively which will bring liquidity to the market. Fintech could also improve interfacing and interactions between IFIs and Non-IFIs through various API and data exchange technologies, and automate back office processes.

Several years ago when I was doing my business degree there was a session on corruption. The course material started with Anna Hazare’s movement in India against corruption, and pretty much went on to project corruption as a thing with the emerging markets. There was a challenge from a Chinese student, who asked the professor “why is corruption being projected as a problem in the developing world, when Billions got wiped out of people’s pensions during the Credit crisis in 2008. Isn’t wall street the most corrupt place?”. Something I have noticed in the West is that if something is legal, it’s considered to be right. No wonder business schools run courses on Ethical business practices. There are a few things that the banking world, driven by capitalistic ideals, could do to make it more principles/values based. And if done so, it would most likely look like Islamic Banking. A few more players in Islamic Fintech could spark a new wave of opportunities both in the West and in the Islamic world. Inshallah! (God willing)

Back to the future of P2P Lending, we interview one of those peers

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The founding idea of both Lending Club and Prosper was Peer To Peer (P2P) Lending. Along the way, professional intermediaries aka Institutions got into the act and we started referring to Market Place Lending or Altfi. P2P Lending means no other intermediaries – just Lender + Borrower + Platform. The imperative to scale fast, to keep equity investors happy, forced the platforms to get capital from professional intermediaries. Something was lost in this transition. Professional intermediaries add fees and also tend to be less loyal as they see their job as moving money around fast to protect their investors. 

Hector Nunez is a good example of those original P2P retail investors. He has been investing in notes on Prosper since the early days. In an ironic twist that tells a lot about Fintech in the capital markets, Hector also has a job as a doorman at 75 Wall Street in New York City, which used to house trading rooms and now has been turned into apartments (in the new FiDi or Financial District of Manhattan). Hector was one of the early investors in Prosper loan notes and turned his $5k original stake into $138k over 10 years. This is a track record that most professionals would envy. See later for how this translates to IRR.

So it made sense to get Hector’s take on some of the big shifts in this market.

What is the difference between retail and institutional investors?

Our thesis is that three things separate the retail investor from the institutional/professional investor:

  1. Access to tools, techniques and data. Fintech is democratizing the tools, techniques and data that used to only be available to professional intermediaries. This is a work in process. Some tools are still only available to professional intermediaries, simply due to how they are priced, but this will change as new players come into the market. Techniques can come from books, blogs, forums and online courses. Platforms give access to data to encourage investors. So it is only tools that are lacking and entrepreneurs who build these tools know that this is primarily a pricing decision and that selling to 100 retail investors at 1c is the same as selling to one Institution for $1 and may be easier. We asked Hector about some of these tools.
  1. OPM (Other People’s Money). Institutions invest OPM. Retail investors invest their own money. To invest well you have to be a) contrarian and b) right. It is hard to be contrarian when you invest OPM – you have explanation risk. Retail investors have no explanation risk. When they are contrarian and wrong, they only have to explain it to the mirror and learn from why they lost.
  1. Concentration. One Institution can lend a lot of money and that is a quicker way to scale a platform than persuading lots of retail investors to use the platform. One retail investor might be able to deploy $300k while an Institution can easily do 100x that i.e $30m (but that $30m can also disappear equally fast as Institutions tend to be more trigger-happy). Getting 100 retail investors to deploy $300k or 1,000 to deploy $30k certainly takes longer, but it gives the platforms more long-term capital. One way to think about the retail investor is like a bank depositor who takes more risk and does more work for a much higher return.

Hector explains how he invests

I asked Hector to explain his investing approach:

Prosper gives borrowers credit grades (“AA,” “A,” “B,” “C,” “D,” “E” and “HR”) in which the investor sees and gets to invest in the loan the way she/he sees fit. In my case, I’m investing in only 2 grades (“B” and “E”). I have other grades but those are the ones that are in beta mode or that I ceased to invest in. Because there are only 3 or 5 years terms, it takes that long to purge the grades that I’m no longer interested in investing. Now one can argue that this is the disadvantage in retail P2P lending in that once something goes wrong, there’s no essential bail out. I would argue that this is actually beneficial because it teaches me to stay away from certain kind of loans with certain kind of attributes. As opposed to “jumping ship” early and probably not learning exactly why the loan went south. So I set a fixed amount of notes in 3 credit grades that I’m going to invest in and that number is 200. diversification is key and that by having 100 loans (notes), the investor is almost guaranteed to have a gain.

Agile Investing and IRR

Institutional/professional investors focus on IRR (Internal Rate of Return). It is a metric that shows performance. Hector, like most retail investors, does not obsess about IRR because he is not selling to investors.

What Hector is doing – and other retail investors work in a similar way – is what I call agile investing. Like agile programming, you start small and add more and refine the approach as you get market feedback (what you win and what you lose).

In Hector’s words:

Here’s what I started with: 5K which 10 years later (this upcoming March) is currently @ ~$138K. Please note that this includes both my trial and error loans as well as my lower interest loans. I started with 5K, then I put in an additional 10K, then 15K, another 30K and then another $20K. Throughout this process I’ve taken out then put some funds back in so overall, my principle is ~$80K and the rest is in excess of principle.

If Hector was running a Fund and pitching OPM for money, he would track all of those inputs and outputs to calculate IRR. That is how intermediaries work and IRR is a useful tool. However, what Hector is describing is how individual investors work which is to experiment and put more into what works. This is what I call “agile investing”. Note that “individual investors” could mean people with a lot of money to invest – think of Family Offices and Prop Traders.  So this maybe the new mode of investing that the micro asset managers use (see later for follow/copy/mirror model investing).

Ceiling?

I asked Hector what kind of “ceiling” he sees for this way of investing.

I cap off 200 loans for each grade that I’m investing, because I believe there is a point where too much diversity negates gains and losses. Also, years ago, Prosper imposed a percentage limit on both retail and institutional investors which affects the monetary amount that I could invest in. Currently it is @ 10% for the 1st 24 hours. In other words, when a borrower posts his/her loan on Prosper, any investor could only contribute (invest) to 10% of the borrower’s total loan within the 1st 24 hours of the borrower’s loan. After that, the cap is lifted and the investor could invest any monetary amount. I only invest to the 10% limit so monetary wise I’m also capped. So my overall monetary ceiling is currently @ ~$400K and my overall note ceiling is currently @ a little over 500 which includes my beta loans. Once, I reach those goals, I will then have to branch out into other platforms i.e Folio and apply my tried tested and proven strategy on that platform.

Hold to maturity or trade on secondary market?

Prosper announced in September 2016 that they were Closing Down Their Secondary Market for Retail Investors. Prosper had been running a secondary market via FOLIOfn since 2009.

This is the sort of tool that Institutions have taken for granted for a long time.

The old fashioned idea of a bond was to hold it to maturity, collecting interest along the way and many Institutions still like to work this way.

I asked Hector for his take on this:

“Personally I’m not affected by this move as I never had plans on selling my notes on Folio. Remember, we had Folio as an option to sell and I knew it and I never bothered to look at Folio to sell my notes. And in that aspect, I believe I was a typical investor and part of the reason why I think Prosper and Folio parted ways. Remember, if loans default, there’s still a chance we can recoup our losses via the collection agency which work on our behalf (as opposed to losses in the stock where there is no chance of recouping). With Prosper there’s a chance that the collection agency can recoup some if not all your principal with the interest (all for a small fee of course which the agency automatically takes from the funds recovered). I did create a Folio account but that was as a security blanket which I would have put in use had the majority of my investment soured. As the story went, it never did.”

Cross platform investing

Institutional investors are strong on diversification. Hector agrees, but has a slightly different take:

“I believe in that old cliche that you should not put too many eggs in one basket. I am all about cross platform investing. Should one platform go south, you have another to pick you right up; however I only believe that to a point. My belief is that too many investments would cancel themselves out leaving the investor with little financial movement either way (gain or loss).”

Hector is referring is what Institutional Investors call “closet indexing”, when investors diversify so much that the end result is very close to an index (which you can buy for very little from somebody like Vanguard).

One way to diversify is to go global. I asked Hector whether he would consider investing outside America, via platforms in those countries. Hector was clear on this front and his logic was interesting:

No and as of now I don’t have any plans on doing so. There are a couple of reasons why. First, I must complete my investment goal on Prosper before I step on to a new Market. I will make an exception with Folio because I already have an account and I’ve been doing my research with them for quite some time. Second, I trust the American market more than international markets because I feel that I have a better pulse on the US market than that of another country. Probably this is because I live in the US. My strategy relies much on understanding their personal financial background in the context of some event that makes them need a loan. Example: A person could be asking for a loan because he/she may have psychological issues and need their medical expenses paid off and the borrower has a pretty decent financial history while another person may be asking for a loan for a vacation and have a questionable financial history. I would lend to the person in medical need not because of what the borrower is going to use my funds for but rather because of their proven financial track history.

Hector ends with what all good investors have – humility and a learn it all attitude rather than a know it all attitude:

Believe it or not I’m still learning on Prosper and still letting my “beta” notes play.

Can I follow/copy/mirror Hector?

One theme that we have been exploring on Daily Fintech is the emergence of Micro Asset Managers enabled by the follow/copy/mirror model:

  • Copy and mirror trading platforms like eToro, Zulu Trade, Darwinex.
  • Thematic investing marketplaces that allow new micro-managers to emerge by creating their own financial product (equity based), and actively manage it; like Motif Investing, and Wikifolios.
  • Even social research platforms like StockTwits are stepping into this space by offering Follow functions and rankings of the subscriber micro-managers.

This is an alternative to either passive low cost index tracking or high cost active hedge funds. The idea is simply to follow/copy/mirror an investor who is investing their own money. This allows a passive investor (who does not want to work hard at the investing game) to follow/copy/mirror the active investor (somebody like Hector) who gets some share of the upside. That active investor does not need to gather or manage investor’s assets, so they do not need to charge an AUM fee. This is a game-changer in the massive asset management business.

Hector was eloquent that IRR % was more important than total funds under management:

I believe that the amount of money one has in investment is not the sign or bar of performance rather it is the rate of return. A person can have a million dollars in stocks and come out at years end with 1.1 million and another investor could have 100K and turn a profit of $20k and it is the latter investor that I would be most impressed with and try to emulate.

The follow/copy/mirror model is working today in VC (Angel List) and in Public Equities and in FX, but I am not aware of anybody doing it in Fixed Income/Lending. Hector is the sort of investor I would like to follow/copy/mirror. I asked Hector for his take on this:

I welcome you and any potential retail Prosper investor to follow my lead. I could give you or anyone nice fundamental tips in getting started as well as giving you warnings and recommendations. If you or anyone wishes to get started, please let me know.

It will be interesting to see if the Lending platforms start to offer this or if some other platform specific to the follow/copy/mirror model offer a cross-platform capability.

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Will Goldman become a verb? Watch the Marcus ads!

Can there be something in corporate names that start with G?

Why is it that GAFA has Google first?

What is the tipping point that turns a corporate name into a verb?

Malcolm Gladwell may have insights on these questions and a great story to tell us, as I urge you to start thinking about Goldman’s transformation.

In Goldman is leading the “Sell-side empowers the Buy-side” movement we looked at Goldman’s move from a top-tier proprietary investment bank and broker dealer, to a player that empowers its clients.

We know that Goldman acquired the GE bank, which has gone relatively unnoticed (up to now) in the fierce consumer banking battle with digital banks. There has been no conference panel with the Movens of the space, in which Goldman’s bank arm has participated. The consumer lending business on the hand, has been discussed often on Lending tracks at conferences. At the recent Lendit conference in London, the insurgents (i.e. Fintech startups) highlighted the delays to launch of the Marcus offering as evidence of Goldman’s (any incumbent’s for that matter) inability to be agile and to gain on “Time to market”.

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Source

The Marcus offering has been talked a lot in the press and the mushrooming Fintech media world (I agree that there have been delays to the Marcus launch) and now we know we details of the first product offering:

  • Marcus is the consumer lending arm of Goldman.
  • Marcus is as we speak going, to flood the “around money” media space (the Personal Financial management- PFM). They will be on Facebook. Youtube, Hulu etc.
  • Marcus has a very strong messaging component.

Dustin Cohn, the head of brand management for Goldman’s new consumer lending arm, Marcus by Goldman Sachs, said the bank’s aim was to “destigmatize debt and help consumers explore new ways of managing their debt.”

This is Apple like. It is about the “Why” not the “What”. If I had credit-card debt, I would feel the urge to hop on a plane to run and sign up for this new consumer debt-consolidation product because:

  • The consumer pays a fixed interest rate on the loan (which includes a profit margin for Goldman). It has no complexities (APRs and all the usual hidden in a credit-card type of arrangement).
  • It is simple and clear. No fees for late payments.
  • It is transparent and simple! No credit-score changes! There is nothing hidden, no optionality (hiding misunderstanding and potentially Goldman outsmarting the user).

Watch the ads to fully understand the messaging (four ads of 30sec each). What is your favorite? Engage in the conversation on the Fintech Genome “Why sign up on Marcus, Goldman’s consumer debt-consolidation offering?

Insurgents claim that Goldman’s Altfi “go to market”, shows how non-agile incumbents are. True that there were delays in the launch. Going forward, the question of how quickly and efficiently Goldman can change and adapt their consumer lending offering, when the market conditions call for it (i.e. pivot offering to beat competition or to scale in other areas) is still on the table.

Whether Goldman will succeed in the consumer lending space, will be seen. What we do know up to now, is that Goldman is successfully and swiftly making business transformations, when the market conditions call for it. Goldman has been making painful business pivots much faster than other incumbents.

Goldman restructured their securities division and 18 partners have left in 2016 as a result of this restructuring.

Goldman is engaging in head to head competition with Morgan Stanley (Goldman has been losing on equities sales and trading) in the retail market.

Goldman has shifted from a prop house to one with empowers its clients, the Buy side.

Goldman has made a strategic shift to increase cross-selling to its clients. This is an ambitious metric to go after, simply because traditionally banks have not been able to pass a 10% cross selling level (i.e. on average only 10% of clients consume 3 or more consumer offerings from one banking entity; 90% of clients have more than one provider for 3 or more of their banking products).

Will Goldman become a verb by using technology and offering “invisible services” under their brand?

Will they be the first incumbent to accelerate cross-selling via Fintech?

Lets watch whether the tipping point unveils itself. Goldman is also under-the radar adopting the API philosophy, to offer access it SecdB database but also very aggressively through its strategic investments in Fintechs. Kensho and Symphony, are the best examples of the Open API philosophy in action.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network.  Efi Pylarinou is a Digital Wealth Management thought leader.