Internet Changes Everything

Looks Like an Old-Fashioned Consumer Credit Crunch

Looks Like an Old-Fashioned Consumer Credit Crunch

Expect shock waves as credit standards and normal risk premiums return to the credit markets

by Dennis Jacobe

GALLUP NEWS SERVICE

PRINCETON, NJ – Once upon a time, a housing- and autos-led recession was a basic feature of the U.S. economic cycle. In those days, there were interest rate ceilings – a legacy of the Great Depression of the 1930s -- on the interest rates financial institutions could pay for deposits. As a result, as the Fed raised interest rates above those deposit-rate ceilings, money flowed out of local financial institutions, creating a "consumer credit crunch" that severely limited the availability of housing and auto loans. In turn, the economy slowed, often going into recession until inflation and interest rates came back down to levels that encouraged money to flow back into the nation's depository institutions.

Of course, all of those artificial regulatory limits on money flows are long gone and with them the experience of a consumer credit crunch. Today's financial markets allow the free flow of money worldwide, making liquidity readily available to consumers, businesses, and investors by way of numerous forms of securitization -- the packaging of loans for sale to investors. In fact, one of the factors extending the economic expansion of recent years and the boom on Wall Street that sent the Dow Jones average to a record 14,000 on July 19 may have been a worldwide glut of liquidity.

Over the past couple of weeks, however, financial market conditions have changed dramatically. As substantiated by the UBS/Gallup Index of Investor Optimism for July, the nation's residential real estate markets continue to get worse, not better. At the same time, the subprime mortgage debacle has many investors concerned about a consumer credit crunch and has sent the Dow Jones average plunging more than 800 points since its July peak. In this regard, the average investor may have been somewhat prescient in UBS and Gallup's most recent poll, because the Index of Investor Optimism declined in July for the second month in a row. In addition, the issues of a significant tightening of global liquidity, a U.S. consumer credit crunch, and the possibility that the current economic slowdown might turn into a full-fledged recession are likely to be major discussion topics as the Federal Open Market Committee (FOMC) meets this week.

Residential Real Estate Continues to Deteriorate

The old quip that the light at the end of the tunnel is really a train coming through may well apply in most residential real estate markets as the summer comes to a close. During the first half of July, 71% of investors said they perceived that residential real estate conditions nationwide were getting worse. This maintains a pattern of pessimism concerning the national outlook for the housing market that has persisted in Gallup's surveys for many months. Further, 78% of investors said the potential for a housing or real estate crash in some local markets was hurting the investment climate a lot (41%) or a little (37%) during July.

It is likely that this national perception has been affected somewhat by the well-publicized problems of various housing markets that once were super hot, not to mention the subprime mortgage mess. As a result, the finding that 60% of investors believe conditions in their local real estate markets are getting worse is of even greater concern. Presumably, most of the nation's investors are much more knowledgeable about their local housing market conditions than they are about those nationwide.

Potential "Consumer Credit Crunch"

A consumer credit crunch takes place as lenders refuse to make money available to many if not most borrowers. During the first half of July, 76% of investors said the consumer credit crunch was hurting the investment climate a lot (40%) or a little (36%). This is not as high as some other investor concerns, such as the worry over energy prices, with 92% of investors saying those high prices are hurting the investment climate a lot (70%) or a little (22%). Still, its comparative newness as a significant investor concern, the general public's lack of recent experience with a real consumer credit crunch, and the fact that the UBS-Gallup poll was taken during the first half of July -- before the equity markets began their recent plunge -- all suggest that the danger of a consumer credit crunch was surprisingly high on investors' worry lists early last month.

Potential for Recession

Over the past couple of years, fears of a potential recession have tended to center on the willingness of the U.S. consumer to continue spending. In this regard, some have seen the bursting of the housing bubble as a reason for the consumer to pull back on spending as the "wealth effect" benefits of past homeowner equity gains dissipated. Similarly, soaring gas prices have been seen as another drag on consumer spending, particularly for low- and moderate-income consumers.

Still, many observers have argued that consumers will continue spending as long as they have jobs and can continue to borrow money. This is where the real danger of an old-fashioned consumer credit crunch comes to bear. A consumer credit crunch, as noted, takes place as lenders refuse to make money available to many if not most borrowers. In fact, even borrowers with top-notch credit scores can see their cost of borrowing surge higher as liquidity is reduced.

What causes a credit crunch? In today's financial markets, many lenders make loans but do not hold them in their portfolios. Instead, they sell them to investors in the form of securitized investments. What appears to be happening in recent weeks is that the huge losses associated with some subprime mortgage investments are not only creating significant new risk premiums but also causing potential investors to shun all mortgage investments not guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae. For example, on Friday various mortgage lenders announced that they could no longer sell various types of jumbo mortgage loans and special feature mortgage loans to the investment markets. As a result, some lenders decided to stop making various types of mortgage loans and sharply increase the pricing of the loans they would make.

Will this kind of consumer credit crunch be contained to selected areas in the mortgage market or will it spread to home equity loans/lines and maybe even to small business loans? The reality is no one really knows -- no one has any experience with this kind of potential liquidity problem. It depends on how much exposure holders of various kinds of securitized debt have and what happens to the value of that debt, particularly some of Wall Street's more exotic creations. What is known is that fears about the potential fallout in the mortgage securities market, not to mention a global tightening of liquidity, are already creating a consumer credit crunch. In this regard as well, the investors in our July poll may have been truly prescient.

Will There Be a Fed Bailout?

When the FOMC meets at the Federal Reserve Board on Tuesday, the discussions may include a number of topics not discussed in those hallowed halls for many years. Inflation, interest rates, economic slowdown, and even potential recession are fairly common topics for monetary authorities. However, "liquidity" is a totally different kind of issue. A lack of liquidity can lead not only to financial failures but also to the failure of the capital markets to function properly. Of all the responsibilities of the Fed, maintaining orderly financial markets heads the list.

At the conclusion of the FOMC meeting next week, monetary authorities may well come out with some reassuring words about the stability of the financial markets and their willingness to stand ready to provide liquidity to the system if necessary. On the other hand, they may say nothing about the liquidity issue, fearing that any statement will only make things worse, not better. Either way, the hope will be that the fears of the past couple of weeks will blow over and the credit crunch can be contained to the mortgage securities market. However, if following the FOMC meeting, the Fed states that it will provide liquidity to various investment banking firms and/or hedge funds, then a much more serious scenario may be underway.

Regardless, the return of a real consumer credit crunch would leave no doubt that the recovery of the housing markets will take a lot longer than previously anticipated and that consumers will have to pull back on their spending significantly. If that happens, then the probability of a recession late this year and into early 2008 would increase significantly.

Survey Methods

Investor results are based on telephone interviews with 800 investors, aged 18 and older, conducted July 1-12, 2007. For results based on the total sample of investors, one can say with 95% confidence that the maximum margin of sampling error is ±4 percentage points. In addition to sampling error, question wording and practical difficulties in conducting surveys can introduce error or bias into the findings of public opinion polls.

August 6, 2007 at 05:02 PM in Consumer trends, Financial Services | Permalink | Top of page | Blog Home

Traditional vs. online banking: Which one is for you?

Richard Burnett | Sentinel Staff Writer
Posted May 27, 2007
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It was a no-brainer for Jim Gilkeson when he found an Internet bank offering a money-market account paying five times the average interest rate offered by conventional banks. He moved $10,000 into the online account two years ago and has earned at least twice as much on his money to date than if he had gone with the best conventional rates available, he says.

"The yields they offer are so much better," said Gilkeson, a finance professor at the University of Central Florida. "And the regular, brick-and-mortar branches haven't been very generous at all with their rates."

Gilkeson is among millions of people who in recent years have surfed onto the Internet in search of a bank account. Known as "direct" banks, the Web-only outlets have used high savings rates and aggressive marketing to capture more than $120 billion in deposits so far this decade, according to Celent LLC, a Boston-based financial-research firm.

They include giant players such as INGDirect and E*Trade Bank; growing ones such as Jacksonville-based Everbank and Palm Beach-based VirtualBank; and little-known ones such as giantbank.com of Fort Lauderdale. Because they don't have the overhead expenses of a brick-and-mortar branch, direct banks can offer higher yields than their conventional counterparts.

Celent's most recent forecast projects total deposits of $380 billion within three years for direct banks, thanks in part to new online products such as Internet checking accounts.

Even though that would still constitute only a small share of the nation's more than $10 trillion in bank deposits, the trend has already drawn the attention of the nation's conventional banks, many of whom now offer Internet-only products to compete with "pure-play" online banks.

The First National Bank of Omaha, for example, recently formed an Internet subsidiary -- FNBODirect, which now offers the highest savings account rate in the nation. The bank said last week it would roll out test marketing campaigns in Orlando, Seattle, Boston and Phoenix.

Experts say conventional banks, like other mainstream businesses, must come to grips with the emergence of younger, Internet-savvy customers who incorporate new technologies into their lives much more readily than older customers do.

Online banking, in general, is expected to expand 55 percent, to 72 million U.S. households, by 2011, according to a forecast by Forrester Research. Among Generation Y customers -- those born starting in the late 1970s -- it's expected to grow a much faster 136 percent, the forecast projects.

"Certainly a majority of bank customers today still look at where a bank's branches are in deciding where they'll do their banking," said Dan Schatt, a senior analyst for Celent. "But when you look at the growing impact of Generation Y and other younger users, there's no doubt online and mobile bank services are having a much greater influence in the marketplace."

The business has not been free of trouble. Just last week, Atlanta-based Netbank Inc. -- one of the pioneers -- announced it would unload its Internet unit to Everbank. Netbank cited problems with subprime-mortgage defaults, which have triggered millions of dollars in losses.

And, despite their growing appeal, Internet banks still have their work cut out for them, even among some young, tech-savvy customers.

"Yes, I've heard of them, but I don't think I'd go for something that sounds kind of iffy," said Tonya Walker, a 21-year-old University of Central Florida student who says she pays many of her bills online. "If I'm doing something with my money, I'd just rather have a place to go where I can deposit it directly. It would make me feel uncomfortable, you know, not to have human contact."

That attitude still resonates with many people, experts say, regardless of their age. Some people want that personal touch with their banking -- a message even Internet banks have gotten. For example, INGDirect, the market leader, has begun opening Internet-cafe-style locations where its customers can get live assistance.

"You may never completely lose the need for some kind of relationship with a local bank branch," said Greg McBride, senior financial analyst for Bankrate.com, a financial-research firm based in North Palm Beach. "The Internet banks may not be for everyone. But for people who do less and less of their banking at a branch or ATM and increasingly via laptop computer, it will be really well-suited to their lifestyles."

The first step when exploring Internet banking is to clear the emotional or technical hurdles that may accompany conducting your personal financial business over the Internet, experts say.

Securing your computer is crucial before you start. Install the latest antivirus, antispam, anti-spyware and firewall software and keep it updated. Beware of e-mail "phishing" -- scams that use realistic-looking but bogus Web links to try fooling you into giving up personal financial information.

Next, check out the Internet banks' various offers. The simplest way to do that is go to www.bankrate.com, click on "Compare Rates," and select from among the savings, investments and other products offered. You can compare the rates available nationally or by state. Internet banks routinely lead the lists.

Bankrate says it verifies that all of the banks it lists are insured by the Federal Deposit Insurance Corp. To obtain more regulatory information about a bank, go to www.fdic.gov, click on "Deposit Insurance" then "Bank Find," which will lead you to the company's latest financials and other data.

Once you see what the Internet banks are offering, you should be aware that all savings offers are not created equal.

Gilkeson, the finance professor, said he found that out the hard way. He had felt so good about his first deal with an Internet bank that he decided to open another savings account with a different online bank. But after signing up, he discovered that the adjustable "teaser" rate had already fallen a few basis points by the time his account was approved. He later found out that, if he needed some of the cash, it took about a month to access the account. Gilkeson also began to receive telemarketing calls from the bank as it tried to "up sell" him on other products and services.

"All of that told me that there would be a variety of experiences with these types of accounts," he said of the online-banking world.

Although customers should expect convenience from an online account, they should be wary of an Internet bank that makes it too easy for someone to set one up, said Avivah Litan, a consumer-finance analyst for Gartner Group, a business-research firm in Stamford, Conn.

In this age of electronic identity theft, financial companies should make it as difficult as possible for an ID thief to obtain and misuse your personal information, she said. Internet banks should have multiple layers of security to verify that online customers requesting access to accounts are who they say they are, she said.

"It sounds counterintuitive," Litan said, "but you want to have some inconvenience when it comes to setting up these accounts."

Richard Burnett can be reached at rburnett@orlandosentinel.com or 407-420-5256.

May 29, 2007 at 03:39 PM in Financial Services | Permalink | Top of page | Blog Home

A Tale of Two Lenders

 

Two startups with similar goals travel very different paths In 2004, while backpacking through Northern California's Desolation Wilderness, Chris Larsen told his buddy John Witchel about the concept of a hoi. Larsen, whose wife is Vietnamese, described how entrepreneurs in that country join cooperatives called hoi, then pool their resources to give one another informal loans. Not long after, the topic came up again as Larsen and Witchel hashed out business ideas at Larsen's dining room table in San Francisco's tony Russian Hill. At the time Larsen, 45, was the founder and chairman of online lender E-Loan, but he was ready for a new challenge. The competitive Witchel, 39, was hungry for another go at the dream: He had watched the software company he had founded, Red Gorilla, disappear when it ran out of money in 2000. What if, they wondered, they started a company that let people bypass banks and get small loans from one another?

Source: A Tale of Two Lenders

Around the same time, across the city in a modest Noe Valley flat, Matthew Flannery, a 27-year-old product developer at TiVo, was receiving long e-mails from his new wife, Jessica. She was a consultant in Kenya and Uganda with Village Enterprise Fund, a San Carlos (Calif.) microfinance organization. The 26-year-old described how she drove from village to village, evaluating the living conditions of business owners who had received $100 loans from the fund. "A little bit of money does so much,'' she wrote. What if, Matthew thought, he started a company that would let Americans lend money to struggling entrepreneurs in Uganda, enabling those entrepeneurs to bypass banks and loan sharks?

In March, 2005, Flannery mocked up a Web site, Kiva.org, which, loosely translated from Swahili, means "agreement.'' A month earlier, Larsen and Witchel had launched Prosper.com, a site that helps individuals loan each other small amounts. Both businesses are pioneers in microlending, a field born in the 1970s that is gaining prominence. Muhammad Yunus, who founded microlender Grameen Bank in 1976, won the 2006 Nobel peace prize for developing the idea of making small loans to entrepreneurs who otherwise might not be able to raise money. Entrepreneurs and philanthropists including Bill Gates and eBay founder Pierre Omidyar increasingly consider microlending an important strategy for lifting people out of poverty.

Kiva and Prosper share more than the goal of increasing access to capital. Both strive to keep operations lean, and both wrestle with a complicated regulatory environment. But Prosper is a dot-com, and Kiva is a dot-org. Prosper is a classic Silicon Valley baby, nourished by $20 million in venture capital and heavy-hitting backers including Accel Partners, Benchmark Capital, Fidelity Ventures, and the Omidyar Network. As a nonprofit, Kiva relies on donations and grants, which so far total $250,000.

The different models affect not only the superficial -- guess which company has slicker offices -- but also the fundamental. One key question: How will the benefits and challenges of each model affect its results? The issue is increasingly relevant for entrepreneurs whose businesses have an explicit social mission, be it protecting the environment or helping the disadvantaged. "Choosing between for-profit and nonprofit is becoming more of a common dilemma for entrepreneurs,'' says Alan Abramson, director of the nonprofit sector and philanthropy program at the Aspen Institute. "This is becoming an uncomfortable choice to make because they're trying to do both.''

Soon after their dining table epiphany, Prosper's Larsen and Witchel each kicked in $10,000 and hired a lawyer to see if their idea would fly with the U.S. Securities & Exchange Commission. In early 2005, they started offering programmers contract work and the promise of equity, and soon they had six employees. "They weren't doing it for charity,'' says the sandy-haired, soft-spoken Larsen. "There was no question we were going to get funded because of our track record.'' In April, Prosper raised $7.5 million from Benchmark and Accel. Prosper moved into a 2,500-square-foot office with furniture left over from a dot-com that went bust. Larsen brought his computer and office chair from home.

Larsen and his colleagues developed a site where those in need of cash can set up an account and list the amount they want to borrow and the maximum interest they will pay. Prosper's analytic tools assign each borrower a rating based on his or her credit record. Other Prosper users then offer a portion of the capital and bid on the interest rate. Those with the lowest bids become lenders. Last February, Fidelity and Omidyar Network invested $12.5 million in Prosper. "We didn't need the money,'' says Larsen, "but we wanted the brainpower.''

At Kiva, Flannery also worked his connections, albeit far less moneyed ones. He asked Moses Onyango, a pastor Jessica had met in Uganda, to gather $3,100 in loan requests from seven businesses, including a vegetable stand and a fishmonger. "The idea was that we would divide the loans into shares and sell them to the friends and family from our wedding invitation list,'' says Flannery. The loans wouldn't collect interest, but the shares sold in three days. Flannery collected the money through PayPal and wired it to Onyango, who then distributed the money to the entrepreneurs. Each succeeded in repaying the loan within the year.

Encouraged, the Flannerys organized a second round; this time, they invited the public to make loans. "I had this idea about sponsoring a business,'' he remembers. "That word was running through my head because I grew up sponsoring children.'' (His family donated to World Vision in the 1980s.) Jessica worked with Onyango to collect loan requests from 50 Ugandan entrepreneurs. Matt built a tool to create MySpace.com-like profiles for each one and sent out a press release. In November, 2005, two high-traffic blogs, Daily Kos and Boing Boing, featured the site. Within three days, 50 loans had been made for a total of $25,000. After talking with his mentor, Bob King at Peninsula Capital, and his brother-in-law, venture capitalist Peter Cochran, with Vulcan Capital, Flannery decided to take the nonprofit route. "What we were doing was highly experimental,'' he says. "I thought that as a nonprofit I could get early support I probably couldn't get from a VC.''

Unlike Prosper, Kiva works only with entrepreneurs, which it finds with the help of microfinance institutions in developing countries. Those partners bring their clients to Kiva instead of to a local bank. Kiva posts pictures of the borrowers on its site and shows how each would use a loan. When a loan is made, Kiva transfers the funds to its partners. Lenders, who are usually repaid within a year, can read blog updates from entrepreneurs they've sponsored.

Last July, Kiva's six employees moved into an airy, 1,300-square-foot office in a Mission District warehouse with exposed brick and an assortment of secondhand furniture. Kiva also inherited its best talent from other places. Chief Operating Officer Olana Hirsch Khan came to Kiva in May after six years in sales at Google, and Premal Shah, who made his fortune as one of eBay's first employees, became Kiva's president last year. Shah and Flannery now earn about $3,300 a month, and Jessica volunteers while she finishes at Stanford Graduate School of Business. Says Flannery: "In the future, we'd like to scale this to the point where people are paid the salaries that will give them incentive to do the work.''

Since July, Prosper's 25 employees have inhabited 111 Sutter, a 9,000-square-foot space with a majestic wood-paneled conference room and a showstopping view of San Francisco Bay. The rent is more than seven times Kiva's. Prosper's employees could do quite a bit better as well: As part of competitive pay packages, they receive options that vest in four years.

In all but four states, Prosper has secured a lending license by meeting the terms of the Fair Credit Reporting Act. So far, Larsen says, default rates roughly mirror those at major lending institutions. Prosper receives 1% of the loan amount; lenders pay an annual servicing fee of 0.5% of the amount they lend. That money leaves Larsen, who is CEO, and Witchel, who is chief technology officer, free to concentrate on building the business and to add new features to the site.

That's freedom Flannery would like to have. He spends three-quarters of his time raising funds. He can't replicate Prosper's model in the U.S. because the legal expenses would be too much. Instead, Kiva plans to expand by introducing low interest rates to attract more lenders.

It is not surprising that Prosper's reach is so much broader than Kiva's. In its first seven months, Prosper's 100,000 registered users have made $22 million in loans, averaging about $5,000. Kiva's 15,000 lenders have made $1.2 million in loans, with an average loan size of $500. That translates into success for both companies, whose founders agree that there is room in the wide-open field for both models. Says Kiva's Shah: "Right now there are so few people doing this and it's so experimental, we need to help each other. If either model has a significant flaw, it could destroy the credibility for everyone."

January 27, 2007 at 05:21 PM in Financial Services | Permalink | Top of page | Blog Home

We can all be bankers now

Telegraph | Money | We can all be bankers now

Last Updated: 12:30am BST 23/08/2006

Zopa, the internet business that introduces borrowers to private lenders, is now 18 months old. Pamela Atherton tracks its progress

You might think that not too many people would be willing to lend money to strangers, but thousands of people are, according to Zopa, the internet company. Zopa is the financial equivalent of eBay, the auction website: it puts borrowers and lenders directly in touch with one another.

It was launched in March 2005 to offer competitive borrowing and lending rates to people by cutting out traditional lenders who make money on the deal. Zopa (which stands for Zone of Possible Agreement) attempts to match small lenders with borrowers - finding the point at which what someone might pay for a loan matches the interest rate another person is willing to lend the money at. In a little over a year more than 88,000 people have become Zopa members.

Sixty-three per cent are borrowers and 37 per cent lenders, with about 50 per cent of active lenders having already added to their original lending outlay.

Zopa is coy about providing specific lending figures but insists that millions of pounds have been transacted since the launch, involving thousands of lenders and borrowers, and that more than 5,000 new members are being signed up each month.

The average gross return for lenders since launch has been 6.83 per cent (including Zopa's 0.5 per cent fee, but excluding tax). Lenders bear the risk of defaults directly, although bad debts to date have affected only 0.05 per cent of the loans made.

What is more, the risk of defaults is diluted by the spreading of any loan across a number of borrowers. In addition, Zopa carries out full credit checks on all borrowers. The appeal for lenders is not only the prospect of higher rates of return than those provided by banks and building societies but also the transparency of the costs and the control that direct lending gives them over their money.

The benefits for borrowers are that interest rates can be lower than those charged by traditional lenders and that there are no early repayment penalties. This has made Zopa particularly attractive to the self-employed and others who, because they have fluctuating earnings, may find it difficult to borrow from the banks and may also wish to repay loans early. Both lenders and borrowers pay Zopa a fee of 0.5 per cent of the loan. For example, if a deal is struck for £5,000 Zopa receives a total of £500.

It also receives commission (which it refuses to disclose) on the sale of optional payment protection insurance. It seems to work. Zopa is currently topping the best-buy tables on websites such as www.uswitch.com and www.moneysupermarket.com and estimates that its loans are about 30 per cent cheaper on average than those that a bank would offer to a prime borrower. The average gross interest rate paid by borrowers to date (on an average loan term of 2.5 years) has been 6.8 per cent (7.1 per cent APR including fees).

A good option for the creditworthy borrower
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Lenders who visit the website are asked how much they are willing to lend, to whom and over what period.

They are then asked to choose the price at which they are willing to lend. Borrowers trawl the Zopa website to see the terms on which lenders are willing to lend and apply accordingly.

Borrowers - who undergo a stringent vetting process - are rated "A''' or "B'' according to their creditworthiness. For example, on Tuesday last week an "A''-rated borrower could obtain a loan of £5,000 over 36 months at 5.34 per cent, whereas a "B''-rated borrower would have to pay 7.1 per cent for the same loan.

These rates include the 0.5 per cent Zopa fee, but not the cost of optional payment protection insurance. When a borrower finds an acceptable rate of interest he or she can apply for the loan. Once the application is accepted, Zopa arranges for the interest to be paid directly to the lender's bank account.

Lenders can make loans of between £10 and £25,000, while borrowers can apply for loans of between £1,000 and £15,000. Zopa boasts a bad-debt record of only 0.05 per cent in the first 18 months of its existence. It attributes its low default rate to its credit-scoring methods for assessing borrowers. These are carried out in addition to the normal checks via the electoral roll and credit reference agencies such as Experian, Equifax and CallCredit.

But it is still early days and whether its credit check system is more effective than that implemented by the banks will not be known for a couple of years.

Martin Lewis, editor of moneysavingexpert.com, says: "Zopa has a low default rate because it only lends to people with very good credit histories and who earn at least £25,000. You can't compare Zopa's default rate with the banks' because they have to lend to a far wider customer base.''

One senior official at a high street bank says: "Typically, we tend to see defaults halfway through the term of a loan, so with a five-year loan they start to emerge after two-and-a-half years. Depending on what Zopa's average loan term is, it seems a little early to be boasting of a low default rate.''

All lenders and borrowers enter into a legally binding contract with their respective borrowers and lenders, while Zopa manages the collection of monthly repayments via direct debit. Borrowers' non-payments are chased in the same way they would be by a bank: they are referred to a debt collection agency and any money collected is returned to lenders.

After 120 days of default, the agency sells the debt on to another financial institution, at which point the lender is offered a final payment and the outstanding debt is written off. Zopa is not a bank, so loans are not protected in the same way as bank and building society deposits. Instead, it holds consumer credit licences from the Office of Fair Trading and is authorised and regulated by the Financial Services Authority, but only for the sale of payment protection insurance.

Lewis says: "Zopa is a reasonable option for someone with a very good credit record to check out what someone on Zopa is willing to lend them. But for anyone with a poor credit history, I would never recommend that they apply to Zopa as it will simply leave an unwanted footprint on their credit reference files that they have applied for credit and been rejected.''

January 1, 2007 at 05:53 PM in Financial Services | Permalink | Top of page | Blog Home

In the future, everyone will be a loan officer

In the future, everyone will be a loan officer | Straight.com Vancouver

Truly brilliant and unique Internet business ideas are rare. Most, like Amazon, are merely a translation or expansion of real-world stores into the on-line realm. Really smart concepts like eBay could only exist in cyberspace and are peer-to-peer based, which means they offer an environment in which individuals can participate in business in a way that was never possible before on such a large scale.

The latest of these great ideas is so far only available to citizens of the U.S. and the U.K., where Prosper (www.prosper.com/) and Zopa (www.zopa.co.uk/), respectively, operate the first peer-to-peer money-lending networks. There are some differences between the two companies, but basically a prospective borrower asks for the loan of a sum of money, and people interested in lending money supply it. Naturally, all the standard rules of credit are in effect, from loan qualification to penalties for defaulting, but the process sidesteps the traditional banking hierarchy. The companies collect a small amount of the loan value as their piece of the pie.

In the October 2006 issue of Esquire, financial columnist Ken Kurson explains that Prosper was started by E-Loan cofounder (with Janina Pawlowski) Chris Larsen. E-Loan, which Kurson extolled as an investment opportunity a couple of years earlier, operates like a mortgage broker service (although for a wider variety of loans). It shops your application around to established lending houses, which either pass on it or make an offer of X dollars at Y-percent interest. What Prosper and Zopa do is more akin to the concept of microlending pioneered in developing countries. (That model just netted innovator Muhammad Yunus a Nobel Peace Prize.) People are graded for their credit scores and interest rates, and post applications. At Zopa, they are further grouped by the proposed length of the loan (one to five years), while Prosper operates with a fixed three-year term. With both companies, however, there are no penalties for early repayment.

On the funding side are people who wish to accept a little risk in order to make more money than a bank deposit provides, just folks with a few bucks to loan out—few being the operative word. Potential bankers with sums in the low two digits are not turned away. Furthermore, you aren't required to lend to a single individual. At Zopa, if you kick in £500 or more, it will automatically be split among at least 50 borrowers. In effect, Zopa is a quasi-traditional lending institution funded by individuals who've contributed at least £10.

Over at Prosper, things are considerably more free-market. People post requests for sums between US$1,000 and US$25,000 and the interest rate they desire, and lenders can browse the requests. Lenders can thus specialize in certain areas (such as helping aspiring audiophiles who “just want to buy some really bitchin' speakers”) or devote their funds to specific user groups like firefighters or teachers. They can agree to take on all of a person's loan request or just throw in a couple of hundred at a specific interest rate. Or you micromanage a little less and just select your desired risk level and/or user group and have the loans made automatically.

Another interesting feature of Prosper is that if a loan becomes fully subscribed and lending offers start coming in at lower rates (i.e., there's competition among lenders or somebody new joins the pool who has a soft spot for firefighters who are aspiring audiophiles) the original people who offered, say, US$500 at 14 percent are sent e-mails telling them they'll have to cut their rate to 13.75 percent if they want to stay in.

Unlike eBay, where the on-line meeting ground serves as an introduction service for a transaction that's completed via personal e-mails and the postal system, with Prosper and Zopa both parties' identities remain confidential. You're not putting up the money for Bob Smith; you're financing a loan request based on credit risk, interest rate, and—maybe—a personal fondness for a specific type of request (car loans for single mothers, golf clubs for retirees). Similarly, Bob Smith will never know if his loan came from one generous benefactor who liked his proposal or 200 smaller ones who liked his credit grade.

It seems to me that there are probably a few bucks to be made underwriting loans—the banks seem to believe it's possible. Kurson says that he favours making high-risk loans (higher interest rates, but with a certain percentage of defaults expected), and has kicked in some cash on 230 requests, pulling in almost a 20-percent return, with 10 loans going more than 30 days overdue and being referred to a collection agency.

I must admit that when I read Kurson's Esquire article, the first thing I did was rush to Prosper's Web site to see how I could become a lender. Unfortunately, you have to be a U.S. resident with a Social Security card. Still, maybe this concept will migrate to Canada in the near future—it's so gleamingly brilliant that it could go viral pretty quickly. (Both of these companies are less than two years old.) Of course, I'd expect the chartered banks to fight against it pretty strenuously, but there might not be much they could do in the present regulatory environment, where even grocery-store chains can spawn financial institutions. So all you bored venture capitalists, here's a great idea just lying there waiting to be picked up. Ladies and gentlemen, start your lawyers.

January 1, 2007 at 05:52 PM in Financial Services | Permalink | Top of page | Blog Home

A new world: Get your mass collaboration road map set

globeandmail.com: A new world: Get your mass collaboration road map set

Traditional business is no longer the sole engine of wealth creation in the economy, DON TAPSCOTT and ANTHONY D. WILLIAMS find

DON TAPSCOTT AND ANTHONY D. WILLIAMS

Throughout most of human history, hierarchies of one form or another have served as the primary engines of wealth creation and provided a model for institutions such as the church, the military and government. So pervasive and enduring has the hierarchical mode of organization been that most people assume that there are no viable alternatives. That is, until a new generation of user-friendly collaboration tools unleashed a new force on the world.

It's like someone uncorked the bottle of human ingenuity. Empowered by the growing accessibility of information technologies, millions of people already join forces in self-organized collaborations that produce dynamic new goods and services that rival those of the world's largest and best-financed enterprises. Though it is unlikely that hierarchies will disappear in the foreseeable future, it's clear that the traditional business enterprise is no longer the sole engine of wealth creation in the economy.

The quintessential example of mass collaboration is Wikipedia -- a collaboratively created encyclopedia, owned by no one and authored by tens of thousands of enthusiasts. With five full-time employees, it is ten times bigger than Encyclopedia Britannica and roughly the same in accuracy. It runs on a wiki -- software that enables multiple users to edit the content of Web pages. Despite the risks inherent in an open encyclopedia in which everyone can add their views, and constant battles with detractors and saboteurs, Wikipedia continues to grow rapidly in scope, quality and traffic. The English-language version has more than a million entries and there are ninety-two sister sites in languages ranging from Polish and Japanese to Hebrew and Catalan.

While Wikipedia's mission is to make the sum of human knowledge accessible, not all examples of mass collaboration are guided by altruism. Take Linux, an open source operating system that emerged from the hacker-fringes of the Internet in 1991. At first, many doubted the efficacy of an operating system developed by a Web-enabled community of anarchist programmers. Oh how the critics were wrong.

Today, more than a hundred million users of set-top cable boxes, TiVos, Motorola Razrs, and other home appliances use Linux, and more than a billion people use it indirectly whenever they access Google, Yahoo, or myriad other websites. If you drive a BMW, chances are its running Linux. All considered, Linux-related hardware and services produce billions of dollars of revenue annually and now IBM, HP, Motorola, Nokia, Philips, Sony, and dozens of other companies are dedicating serious resources to its development.

What should today's business manager make of this? First, if you can make an operating system and encyclopedia through mass collaboration, consider what might come next? How about a mutual fund (http://www.marketocracy.com), a peer-to-peer lending system (http://www.zopa.com), designer t-shirts (http://www.threadless.com), or just about any physical good one can imagine (http://www.cambrianhouse.com)?

Second, don't assume that the new collective action represents only a threat to established businesses. While some fear mass collaboration will reduce the proportion of our economy that is available for profitable activity, smart firms are proving otherwise. Networked models of innovation and value creation can bring the prepared manager rich new possibilities to unlock innovative potential in a wide range of resources that thrive inside and outside the firm. For example, IBM estimates that working with the open source community saves it nearly a billion dollars per year over what it would cost to develop a Linux-like operating system on its own.

Finally, get your mass collaboration road map ready. Barriers to entry are vanishing and the trade-offs that individuals make when deciding to contribute voluntarily to projects and organizations are changing, creating opportunities to dramatically reconfigure the way we produce and exchange information, knowledge, and culture. Companies that recognize, address, and learn to tap mass collaboration will benefit, while those that ignore and resist will miss important opportunities for innovation and cost reduction, and may even go out of business. Now that the genie's been unleashed, there's no putting it back in the bottle.

Don Tapscott is CEO of New Paradigm, a technology and business think tank, and the author of 10 books about information technology in business and society, including Paradigm Shift, Growing Up Digita.

Anthony D. Williams is an author and researcher with experience in the impact of new technologies on social and economic life.He is vice- president and executive editor at New Paradigm.

Wikinomics

Forget everything you know about the way we do business. Mass collaboration is revolutionizing the corporation, the economy, and nearly every aspect of management. In this seven-part series, Don Tapscott and Anthony D. Williams, co-authors of Wikinomics: How Mass Collaboration Changes Everything, due out Jan. 2, explain new business models that will empower the prepared firm and destroy those that fail to adjust.

December 26, 2006 at 10:07 PM in Financial Services | Permalink | Top of page | Blog Home

Social lending over internet cutting out the banks

Social lending over internet cutting out the banks | 24dash.com - Bill Payments

New study shows that Brits are looking for an alternative to high interest rates – Social Lending over the internet

Big banks watch your backs - the British public is looking for an alternative, with 74 per cent of Britons stating they would consider either getting a loan or lending money through a social lending community, rather than their high street bank, according to a new study.

While the study found that people who used high street banks thought they were necessary for general everyday banking, 49 per cent stated that they feel that banks do not have their customers' best interests at heart, 81 per cent agreed that the banks are self interested and 76 per cent strongly agreed that the banks are greedy.

'Internet-based Social Lending', an in-depth study by the Social Futures Observatory, looked at the growing phenomenon of Social Lending.

Borrowing and lending money person-to-person, rather than through a bank is an age-old concept, but in the past has normally taken place in private – through friends, family or other close-knit social groups. Social Lending, now facilitated by the Internet, is emerging as a new financial category of genuine importance. Social Lending is when people lend and borrow money, side-stepping the banks in order to get better loan rates and better returns than their savings account, and a fairer deal for everyone.

The study found that Social Lending is growing in popularity, much like other social networking sites that have seen huge growth with the likes of LinkedIn, YouTube and MySpace.

The reasons for this are due to the increased transparency and connectedness with others that comes from lending to and agreeing loans amongst like-minded people. Just as importantly, it offers people strong financial benefits – higher rates of return on investment for lenders, and a lower rate of interest than is offered by banks for borrowers.

The study looked at a number of Social Lending players, and used Zopa, the online marketplace where people meet to lend and borrow money, as a case study. Zopa, which was set up by many of the team that launched Egg, currently has 105,000 members in the UK.

According to Professor Michael Hulme, who authored the study, "Traditional Banking emerges from this report as almost some form of necessary evil. For most people banking does not provide any form of rewarding or valued experience it is simply a necessity. In contrast to this the Community Sites we looked at appeared to offer a much deeper appreciation of the individual that went far beyond the actual transaction."

James Alexander, co-founder and CEO of Zopa, believes that not only are people looking for a better financial deal, but also for a way to make their money human again.

"We've seen a strong return to ethical values in recent times, with many of us concerned about the impact we, and the organisations we deal with, are making on the community we live in. Lending and borrowing money from real people online, through marketplaces such as Zopa, allows people to get a much better financial deal than what's on offer on the high-street.

"People are already seeing the benefits – for example, those lending at Zopa have since launch received about a 50% better rate of return on money they've lent out than if they'd left their money in the best savings accounts such as ING Direct or Egg."

According to the survey, 64 per cent of people who use high street banks felt it was important that their banks provide a service that enables social interaction and community participation, yet only 13 per cent felt their bank significantly enabled either of these things.

Additionally, 56 per cent said that the more social and interactive features of Social Lending would be a significant factor in their decision to use a Social Lending scheme and 18 per cent stated that investing in people rather than institutions would motivate them to use Social Lending marketplaces such as Zopa.

December 26, 2006 at 09:57 PM in Financial Services | Permalink | Top of page | Blog Home

Prosper.com rounds up a community of dollars and sense

CSIndy: The loan rangers (December 7, 2006)

Prosper.com rounds up a community of dollars and sense
by Josh Johnson

Like many Americans, I’m in debt. Serious debt. I owe more money than I make in a year.

With the federal government operating at $8.6 trillion in debt, and with American consumers owing nearly $2 trillion — more than the gross national product of many industrialized nations — to credit card companies and other creditors, some might say that debt is the American way.

My debt is so scary that I’ve largely ignored it, unable to deal. I’ve contended with multiple daily messages about “an important business matter,” but otherwise, not facing it has been a fairly easy way of managing it. I can’t get a mortgage with an interest rate short of robbery, and even credit card companies have shunned me, so I get by paycheck-to-paycheck, trying not to increase my debt.

“Ignore it and it’ll go away,” however, is not a long-term operating principle. I was unemployed for much of 2006 and discovered that many employers now run credit checks on potential employees, as do landlords. My credit report can affect my housing and employment, and I had no idea what the report even said. It frustrated me that my secret past of fiscal irresponsibility was used to judge me, ultimately keeping me back.

So I set out to face the monster. I went to TrueCredit.com and bought my credit reports for $29. Beer in hand, I saw myself as the credit world sees me.

As a student, I took out the largest loan allowed each semester, for tuition and living expenses, sure, but also for stereos and other items not directly related to my education. My student loan account is now horribly delinquent, weeks away from defaulting. The credit cards are already in default. Library fines and parking tickets have been sold to collectors. I also have bounced checks from now-closed accounts and am years removed from a host of other small financial missteps.

After figuring out which accounts need to be paid now and making deals with others, I arrived at the amount needed to bring me current and on the road to better credit: $1,700. Not bad! Problem is, I’ve dug a hole so deep no one will risk helping me out, and I have no savings to halt that number from doubling. No credit card will give me a $1,700 line of credit, and when I applied for a loan through my local bank, I was told, “It’ll be difficult for you to do anything.”

I could go to predatory lenders, like a payday-loan agency or high-risk lenders disguised as credit counselors, but with payday loans in Colorado at an average 345 annual percentage rate (APR), I could dig myself deeper. Simply put, I have no access to credit. All reasonable creditors see me as a number. They don’t look beyond and see the human desperately trying to make good and right the wrongs.

Enter Prosper.com.

‘Libertarian paternalism’

Some years back, Chris Larsen had a “sleazy” mortgage experience that left him feeling ripped off, with the impression that the credit system in America is corrupt and generally “mucked up.” He set out to change things by starting eLoan, an online mortgage, home equity and car-loan lender. eLoan was a success, doing more than $27 billion in business over the Internet. But Larsen dreamt of further democratizing lending.

“We started thinking with the eLoan experience, ‘Well, what would be the ultimate model here?’ and kept coming back to an eBay for money,” he says. “eBay has been so great at democratizing. They’re bringing capitalism to the masses.”

Last year, Larsen sold eLoan for $300 million, and he launched Prosper.com in February. Today, Prosper has more than 100,000 members with $23 million in loans.

Prosper’s framework combines the peer-to-peer marketplace of eBay with the social networking of MySpace. Borrowers seeking between $1,000 and $25,000 post profiles explaining their need for a loan, and lenders bid on the most attractive loans the same way eBay users bid for products — except the lowest interest rates, not the highest offers, win.

Most loans are funded by dozens of lenders who bid $50 each, the minimum allowed. Prosper keeps a 1 percent loan-originating fee (a one-time $25 charge for a $1,000 loan), and bills the lender a 0.5 percent annual loan-servicing charge. Borrowers have three years to pay off the debt, with no penalty for pre-payment. Basically, Prosper is a peer-to-peer lending auction with a human element.

One of Larsen’s missions at eLoan was to be “radically pro-consumer,” and he’s brought that ideal to Prosper. In most lending situations, the borrower approaches the lender, putting the lender in a position of power. Prosper turns that model on its head. Here, the lenders seek out the borrowers, who set the details of their loan, including a cap on the interest rate they’re willing or able to pay.

Larsen calls this “libertarian paternalism.” Anyone who can clear an identity check can post a listing. And any American with $50 can bid on that listing. Lenders can assess their risk using methods such as credit ratings based on a borrower’s actual credit score. And the borrower’s debt-to-income ratio — marked with a red warning label if the ratio is high — cautions lenders against those who may not be able to afford the loan. From that point, the market is open to do what it will. Prosper is merely the tool, the venue.

As a result, the diversity of borrowers on Prosper is impressive. There are the entrepreneurs seeking start-up capital; those seeking car loans at lower interest rates and more manageable payment schedules than offered by dealers; and the people with terrible credit history trying to get a fresh start.

A quick survey of the site reveals some compelling stories. One single mother, an Iraq war veteran, is trying to consolidate her debt in order to get back on her feet. She’s posted pictures with her children and lays out her monthly budget for all to see.

A professional woman recently diagnosed with cancer needs $25,000 to front her chemo treatment until the health-insurance paperwork is processed.

$ocial networks

Many of the borrowers are people who, for numerous reasons, are not able to get credit elsewhere, and many of these people find loans on Prosper. Tales of funding someone with such dire needs can warm the heart, but Larsen is quick to clarify that Prosper is not an altruistic endeavor.

“We’re a for-profit company,” he says. “If we’re ever really going to take on this trillion-dollar credit market, just for unsecured credit alone, there really needs to be a model that can sustain itself, not just through charitable contributions, but through good returns on investment.

“We believe, much like the eBay sort of mission, that most people are good, and if people are given open access to trade, good things will come. You could probably track all the evils of predatory lenders, payday lenders, all the bad stuff that happens in credit, back to lack of transparency, lack of access.”

Some have compared Larsen to Ralph Nader for his consumer-rights fervor. In California, where Prosper is based, Larsen put up $1 million for petitioning and acted as a mediator between legislators and financial institutions to pass a law that prevents the buying and selling of financial information without notifying the consumer, a practice Larsen says contributes to the proliferation of identity theft. He’s also worked to create greater consumer access to credit information, which was highly guarded by the industry until 2001.

“Consumers need to be on an equal playing field with lenders who have that information,” Larsen says. He uses the example of an auto dealer to illustrate his point.

“Just when you’re at your lowest low, he gives you a rate that’s probably five or six points higher than what you really should be getting. Then he’s turning around and selling it to Wall Street at the real price, and he’s making a killing. That can only happen when there’s lack of access. Can anybody else see that transaction in America? Does anybody else see what it actually sold for on the capital markets?”

As much as they run the risk of getting screwed by traditional loans, solo borrowers on Prosper, especially those viewed as higher-risk by lenders, have a harder time getting a loan. For them, there are Prosper groups. Apple User Group, Independent Filmmakers, Funding Your Wedding, Corporate Divas, Minorities in Need of Money, Christian Opportunities — there’s a group to suit every user.

Groups primarily act as social networks. Users apply to a group, and the group leader accepts or denies the application. Some group leaders require a meeting or phone call, a bank statement or full financial vetting. The best groups are the most difficult to join.

Good group leaders act as mentors, reviewing member listings before they’re posted and offering advice. Lenders will reference a group’s rating and its members’ repayment histories when considering a loan. Groups essentially vouch for their members, and a member’s poor repayment history affects the whole group. Prosper kicks back some cash to group leaders whose members pay on time, and the leader can choose to share it with the group or keep it as compensation. Many members make money as they repay their loans.

More importantly, groups introduce what Larsen calls the “shame factor.” Group members feel compelled to repay their loans to avoid the shame of letting their group down.

“How will you be looked at in your community if you do not repay your debt?” asks Larsen. “That’s something that America’s sort of lost.”

The hui way

Prosper, upon first glance, may seem like a new idea, but it’s not. Larsen references the classic holiday film It’s a Wonderful Life.

Back then, with small community banks, borrowed money was actually a neighbor’s money. Prosper simply cuts out the middleman. While the neighbor may be earning 3 percent interest on his $5,000 savings deposit, the borrower is paying 19 percent interest on her line of credit from the same bank, for the same amount. Meet in the middle at 11 percent on Prosper, and she pays eight points less while he makes eight points more — a win-win.

Inspired by eBay, Prosper.com founder Chris Larsen is relying on the goodness of everyday people to transform the loan industry.
Photo courtesy of Chris Larsen
If a lender were truly a neighbor, the borrower would feel more inclined to pay on time, to save embarrassing encounters at the curb while putting out the garbage. This “shame factor” is lost when dealing with a large, faceless institution. With Prosper groups, borrowers are accountable to real people. But this is not an innovative concept.

“Prosper was partially built on a Vietnamese system called hui,” Larsen says. “It’s a system of peer-to-peer lending, where a small village will get together; 12 people participate, six will be lenders and six will be borrowers. And it works very strongly on that sense of accountability for the community.”

What’s missing here is a lender’s ability to diversify. Rather than lending $5,000 to an individual at 20 percent, lend $50 to 100 people with the same interest rate. Should one of them default, the rest will cover the loss. In many cultures, community members lend and borrow among themselves. Rotating savings and credit associations (ROSCAs) are an example, and Prosper is a kind of American version.

What Larsen calls the “shame factor,” Muhammad Yunus calls “solidarity.” Yunus pioneered microcredit, a system of giving small loans to those who otherwise would not have access to credit. He, along with his Grameen Bank, won the Nobel Peace Prize this year for fighting poverty using the method. Yunus believes credit is a basic human right.

The United Nations declared 2005 the International Year of Microcredit. Microcredit generally works with philanthropists making guarantees, dollar amounts not donated but placed as collateral should loans default. The guarantee remains in an investment account while microfinance institutions (MFIs) use it to back small loans to the world’s poor and extreme poor, who have no access to credit or banking of any sort.

Conventional wisdom would say loaning money to the poor and extreme poor is not good for lender or borrower, but Yunus has proven differently. A small loan of less than $500 is often all that’s needed to lift the poor out of poverty. Of those who’ve remained in Yunus’ program for more than five years, more than 50 percent have pulled themselves out of poverty, he says.

Yunus’ work also shows that the poor tend to make natural entrepreneurs. Their fight for survival has taught them efficiency, frugality and creativity in getting the most out of their money. With a small loan, a person can buy a goat to breed and sell the offspring, or start another business. And, perhaps most surprisingly, the available numbers show that the poor are fiscally responsible.

“Well-run MFIs typically have a default rate of less than 2 percent,” says Kyle Sayler, senior vice president of portfolio management for MicroCredit Enterprises. And while industry-wide numbers are not available, he suspects the average repayment rate is somewhere around 96 percent. “Repayment rates are better than in traditional banking in the U.S.”

MicroCredit Enterprises is a relatively new organization whose employees work mostly pro bono to raise money for MFIs within communities. Like many MFIs, MicroCredit prefers to work with women. And 96 percent of Grameen Bank’s loans are awarded to groups of women.

“Some would say women tend to repay better. I don’t know if that’s the case or not,” Sayler says. “In our case, when women increase the income in their families, they’ll take a greater share and put it toward food or clothes or education for their children.”

Sayler spent two years running an MFI in Chiapas, Mexico, and says one factor that contributes to high repayment rates on microcredit loans is the willingness of group members to cover a payment for another member when she cannot.

“It worked because they came from the same community, and they self-selected their group,” he says. “We didn’t force anyone to work with anyone they didn’t want to.”

As MFIs prove that the world’s extreme poor are responsible borrowers, the giant, for-profit banks are eyeing a slice of the pie.

“I think there’s a big divide in the industry right now between fear of commercialization and pushing commercialization,” Sayler says. “There’s a little bit that makes me fear making money on the backs of the poor. But at the same time, I think [commercialization] causes MFIs to operate more efficiently. Increase in competition and efficiency pushes down interest rates to the poor.”

After all, those receiving microcredit through MFIs or Prosper all have the same goal: profit.

Live long and ...

Andy Mowery is a Fort Collins entrepreneur and leader of the Prosper group An Entrepreneur For Sure!

“We look for serious entrepreneurs,” he says of the group. “If they don’t have a written business plan, they have a concrete idea of what they want to do with the loan.”

Mowery began selling home, garden and pet supplies on eBay in 1999. Today, his company, Debnroo, has grown into a 2,500-square-foot warehouse in Fort Collins, and he expects to do about $1.1 million in retail sales this year. Revenue doesn’t always mean ready capital, however, and so when he needs cash in hand, he turns to Prosper.

“We most recently took out a $25,000 Prosper loan to buy a container of a product that we’ve been selling for over four years, and it was a single opportunity to get the item at a deep discount.”

A single opportunity, Mowery says, that needed to happen in 72 hours. He found an investor to float him the capital for two weeks while he waited for a Prosper loan.

“Fourteen days is not a lot of time. I’d challenge anybody to try and do that with a bank,” he says. “I think the process through traditional banks is antiquated.”

Mowery got the loan through Prosper, and he now uses his know-how to mentor others in getting loans.

James Carothers had maxed his credit and needed to clean it up before applying for a Small Business Association loan to purchase the Moose Creek Café in Walden. He joined the group Business Loans for Entrepreneurs!, and with no mentoring, Carothers received a $5,000 loan from 26 lenders, most of whom put up the $50 minimum.

Carothers had a middle-of-the-road credit rating at the time he got his loan, with a debt-to-income ratio of 17 percent — not low. His group’s track record and his personal listing — which noted a financially crippling car accident 13 years prior, his Christian faith and his post on the town council — brought skeptical lenders to his side.

“I had it funded in less than four hours,” he says. “I hope to leverage myself in the next six months into a position where, rather than a borrower, I’ll become a lender to help other people out.”

While Prosper lenders certainly look for attractive returns, those who post listings that appeal to emotions and present a human face get funded. Apparently, lenders like to think they are helping out.

“You’ve got to be able to communicate to people that there’s a human being behind the screen name and tie in emotional aspects,” Mowery says. “Emotion works. That’s part of what marketing and salesmanship is all about.”

Whose de-fault?

My first loan application on Prosper, for $1,000, was a terrible failure. My credit rating lists me as high-risk, though my debt-to-income ratio is the lowest possible at 1 percent. Colorado caps interest rates at 21 percent, and most lenders don’t see that as a high enough risk-to-return ratio.

Immediately after I posted my listing, I received multiple messages from well-intentioned users offering suggestions. I was told to detail my four current defaults, vet my personal finances and, please God, join a group already.

So I joined the first group I found, one with 910 members who I knew would accept my poor-credit self. Its obnoxious name — “More loans FUNDED @ LOWER % than ANY other group” — gave me hope.

So I posted for another loan, now backed by what I thought was a successful group.

I got messages from the same people who replied after I posted my first loan. I was scolded: “Have you learned nothing since your last listing?” Apparently, lenders shun my group. They say the group leader can’t hold 910 people accountable and offers no mentoring. And I never heard from the group leader.

I soon withdrew my second loan application.

Fort Collins’ Andy Mowery, a Prosper.com borrower, is looking to give back — literally — as a lender.
© 2006 Laura Katers
In order for Prosper to work for me, I must do more homework. I need to scour the message boards for comments about groups and join one that’s right for me. I need to post a transparent profile that explains in detail why I’m in this situation and how I plan to budget payments. I need to build lender confidence.

But in the back of my mind, I wonder, “If I get this loan, will I make payments on time, or will I fall back into old habits?” Prosper gives credit to those who can’t get it elsewhere, but if I fail to uphold my end of the deal, I’ll be sent to collection agencies. Yet if I make payments regularly, it’s positively reflected on my credit report.

“Sometimes credit is something that completely turns around somebody’s life; they could start a business,” says Larsen. “And sometimes credit for a person at the wrong time in their life can actually be detrimental.” I’m looking to the world’s poor for an example.

Josh Johnson is a former contributor to the Colorado Springs Independent and current associate publisher at the Rocky Mountain Chronicle, where this story originally appeared.

December 8, 2006 at 10:52 PM in Financial Services | Permalink | Top of page | Blog Home

Integrating the Channels

http://www.banktech.com/printableArticle.jhtml;jsessionid=XWF44MCHDKT04QSNDLRCKH0CJUNN2JVN?articleID=193402868

Nov 01, 2006
URL: http://www.banktech.com/showArticle.jhtml?articleID=193402868

Channel Management

The development of banks' overall channel strategies has been anything but deliberate. Delivery channels have grown from need and technological advances, and banks' channel strategies have evolved in response. But now that financial institutions are juggling numerous channels and the multitude of ways in which they touch customers, many banks are actively looking to integrate those delivery channels more strategically.

According to an August survey from the American Bankers Association (Washington, D.C.), usage of the major delivery channels is decidedly split. When 1,000 consumers were asked what banking method they used most often, 32 percent said the branch, 26 percent said online, 26 percent said ATMs, 5 percent said the telephone and 5 percent said traditional mail (6 percent said other/none). But statistics on channel usage -- by age, gender and wealth, for instance -- abound.

Generally, current research indicates that the branch and the Internet are the key buying channels for banking products. A recent survey from Framingham, Mass.-based Financial Insights reports that the branch remains the most utilized channel, with almost 75 percent of consumers visiting a branch at least once a month. However, according to the survey, customers who use the online channel tend to have more interactions per month with their financial institutions: 25 percent log on more than 10 times per month.

According to research from Cambridge, Mass.-based Forrester Research, 82 percent of consumers still prefer the branch for opening a new account. Yet there is a strong difference in channel preference by age. Younger generations overwhelmingly prefer the online channel and are more likely to adopt online banking activities, Forrester reports.

The bottom line is that no channel is an island unto itself, says Karen Massey, a senior research analyst with Financial Insights' consumer banking and credit practice. "All channels are important to consumers for the specific purpose each serves," she writes in a new report from the research firm. As a result, Massey urges banks to invest in a consistent customer experience across all channels, including integration of real-time cross-channel data.

Seamless Customer Experience

The current focus in banking is on customer-centric, rather than product-based, strategies. And customers have strong demands. Consumers want to bank on their own terms -- they want access to their money anywhere, and they want it now, said Bart Narter, senior analyst, banking, Celent (Boston), during a recent BS&T webcast, "SOA for Multichannel Integration." "That has been a challenge for the banks," he noted.

Customers are spoiled by general retailers, says Jerry Silva, TowerGroup (Needham, Mass.) research director for retail banking and delivery channels. Some large retailers allow customers to order products online and then pick them up at the nearest store location, for example. But because of the way bank channels have been set up, with different products maintained in different silos and with no real interface to unite the systems, many banks haven't been able to deliver this level of service to their customers, Silva says.

"It's important for customers to feel like a bank really knows them," says Alex Hart, president and CEO of online banking solutions provider Corillian (Hillsboro, Ore.). The customer should get the same information at the ATM, the branch and online, Hart stresses -- there has to be consistency across those channels. At too many banks, he contends, that is not the case. "[Channel integration] is really designed to create a better user experience; it creates preference and differentiation," Hart says.

SOA for Multichannel Architecture

"Firms need to build integrated channels that facilitate customer information and process flows," said Peter Tebbenhoff, product marketing director for Palo Alto, Calif.-based business integration and process-management software provider TIBCO Software, during the BS&T webcast. "Only then will banks be able to achieve the operational efficiencies they had hoped for," he added.

But most banks must overcome legacy architectures that have been built piecemeal as the result of the emergence of new channels and products, as well as M&A activity, Tebbenhoff said. Maintaining legacy systems is time-consuming, prone to error, expensive and inflexible, he noted.

The best approach to achieve multichannel integration, according to Tebbenhoff, is a service-oriented architecture (SOA). "Enabling channels to interact with core applications allows banks to pull out the detailed data embedded deep in core systems spread across the enterprise, translate it into comprehensive, meaningful information, and enable its consistent availability across all of the delivery channels to internal and external constituents," according to a TIBCO report, "Using SOA to Cash in on Multichannel Integration."

A trailblazer in this area is The Huntington National Bank in Columbus, Ohio ($36 billion in assets). According to TowerGroup's Silva, "Huntington is the poster child of multichannel integration."

Dan Vermeire, SVP and chief technology officer for the bank, says a determination to improve the customer experience motivated Huntington to integrate its sales and service channels. "Huntington is incredibly focused on customer service -- on making sure that the things we do end up in positive experiences for our customers," Vermeire says. "We want to see things done consistently and accurately [across channels]," he adds.

"Banks have an intense number of ways in which we touch our customers. ... As those technologies evolved, it was not easy to integrate [them]," Vermeire continues. "Delivery channels exploded and customer experiences were starting to become disjointed. They weren't always receiving the same information or the same approach in service and delivery from one channel to the other." To clear up any customer confusion and create a more seamless experience, Vermeire says, he wanted an integration architecture that was designed specifically to deliver consistent information and experiences across the bank's channels.

Forrester senior analyst Mary Pilecki echoes Vermeire's sentiments. "The consistent customer experience is more targeted toward getting the same answer to the same questions," she says. Customers all have a preference for a particular channel, but no customer base will be homogeneous in its preferences, Pilecki observes. Therefore, banks should aim to provide a common experience across channels. The common experience can be delivered through a business process management (BPM) suite, Pilecki says, and SOA can enhance the BPM.

Huntington partnered with Columbus, Ohio-based software provider Synoran for its SOA platform. The Synoran solution enables Huntington to see a real-time picture of all of its customers across all of its channels, leading to a total view of the customer, according to the bank's Vermeire.

After Huntington's initial investment in SOA, the bank first integrated its self-service channels and then began to focus on the platforms used by its associates for sales and service capabilities, Vermeire explains. "We look at it as an overall business strategy and journey," he says. "[It's] a road map that's focused on customer needs and business changes."

A multichannel integration platform provides three major benefits: customer responsiveness, operational efficiency and a huge degree of savings by reducing errors, according to John Knightly, VP, industry and partner marketing, for San Jose, Calif.-based enterprise infrastructure software provider BEA. The banks that want a "walk-before-you-run approach," he says, start with a specific channel and specific goals. They build modular components and then realize that they can use those in other channels. "A more visionary bank" wants to do it all at one time, Knightly says.

Preparing for Growth

Waterbury, Conn.-based Webster Bank is an example of such a visionary bank. In early 2004, Webster ($18 billion in assets) decided to replace all of its core banking systems to support future growth. "We wanted an IT infrastructure that would support a bank double or triple our size," explains John Kershner, the bank's CTO.

In conjunction with the decision to upgrade its core infrastructure, Webster decided to implement SOA, Kershner says. When the bank selected Jacksonville, Fla.-based Fidelity National Information Services for most of its core banking applications, it was with the agreement that the vendor expose its mainframe systems to Webster through SOA, he says. "We require all of our strategic partners ... to expose their systems to us through Web services for easier systems integration," Kershner explains.

The bank evaluated a number of vendors for its SOA platform, including IBM (Armonk, N.Y.), TIBCO, WebMethods (Fairfax, Va.) and BEA, and then constructed a proof of concept for which the vendors came into the bank to design and develop an application to the bank's specifications, according to Kershner. Webster eventually chose BEA. "What set BEA apart was ... the fact they could bring in a small, knowledgeable team [that] could develop the code within the two-week time frame we allotted," Kershner says.

The BEA WebLogic Enterprise Platform is an open platform that integrates all customer touch points to deliver a consistent customer experience, BEA's Knightly says. The benefits of the infrastructure, he asserts, include obtaining a single view of customers, more-successful channel updates, integrated contact centers, streamlined account creation and improved cross-sales rates.

Over a 15-month period beginning in early 2004, Webster replaced its core banking systems, put in a new ATM system, installed the SOA platform and then integrated all of the bank's front-end delivery channels -- including ATM, branch, call center, Internet banking and voice response unit platforms -- back to the core systems through the SOA. "It's provided us the foundation and infrastructure to easily integrate new applications, to add cross-application functionality, and to add products and services more rapidly," Kershner says. "It has improved IT's ability to turn around projects much quicker by utilizing services that may have been developed for one channel or system to another. It's reduced the complexity of managing hundreds of point-to-point interfaces and has made us more operationally efficient by just managing one integration layer."

But Webster's channel integration efforts aren't complete just yet. "Our vision for multichannel integration is to enable customers to begin a process like a loan or deposit application in one channel and complete the process in another," Kershner says. "Our next steps are to do more business process refinements that improve our customer interactions," he adds.

"SOA is something that you implement because you plan to grow and change," Kershner says. "It helps you quickly adapt to business changes and business demands." Customers experience the benefits of SOA, he adds, in Webster's abilities to provide new products to the market faster than before, to provide more customer information to service representatives and respond more quickly to service requests, and to offer consumers more and easier ways to interact with the bank.

Kershner acknowledges that the path Webster took to integrate its channels is not likely to be emulated by many institutions, as it's not often that a large bank replaces all of its core banking applications at one time. Still, he recommends that banks tie an SOA implementation to the purchase of one or more new business or channel applications. "It is much easier to demonstrate the business case for SOA when you package it with other business functionality that can be delivered directly to the business lines," Kershner explains. "Spending money to integrate new business applications into an old point-to-point architecture is a waste."

Seattle-based Boeing Employees Credit Union (BECU) had a slightly more modest goal for its SOA initiative and multichannel integration, according to Kyle Welsh, director of technology services for the credit union. "We wanted to get to a hub-and-spoke architecture just so we could be more efficient, so when we rolled out products and services we didn't have to do redo interfaces all over the place," he says.

BECU replaced its core system and integrated its channels in November 2002. As a result, Welsh says, the credit union is able to greatly speed up its time to market for new products.

Welsh offers some pointed advice for other banks. "Don't try to boil the ocean," he says. "When you are implementing SOA, don't try to do it all at once." Only integrate the systems that make sense and those that will deliver the most "bang for the buck," he says.

The Payoff

Ultimately, regardless of the path taken to get there, multichannel integration pays off in higher customer satisfaction, says Frank Florence, VP and chief marketing officer for Chordiant Software (Cupertino, Calif.). "Consumers ... are more than ever prone to switch banks," he says. Integrating delivery channels creates a more-seamless cross-sell atmosphere, he says, promoting growth.

By making delivery channels user-friendly and seamless, banks will encourage customers to do more business with them, Forrester's Pilecki says. But banks also will incent staff by streamlining the process, she adds, as it will be easier for them to open new accounts, for example.

Channel integration also creates cost savings, Pilecki points out. Rules change a lot, particularly from a regulatory perspective, and a big expense is tied to that, she relates. But those costs can be cut if you only have to make the change once and it then can be applied across all the delivery channels, Pilecki notes. "Just by enabling a common process and being able to change that in one place reduces IT costs tremendously," she explains.

Still, multichannel integration really is about creating a better user experience to drive growth, says Corillian's Hart. It creates preference and differentiation, two holy grails in the financial services industry, he asserts.

Organic growth is driven by selling more to existing customers, TowerGroup's Silva adds. If a bank gives its customers consistent service that other banks can't deliver, "that will be the wow factor that will differentiate [it]," he says. *

Multichannel Integration: The Next Steps

Imagine that an online banking customer has a question late one night when checking his or her accounts. If that customer had the option of instant messaging a contact center representative and getting an instant answer to the question, that would make for a contented customer. Integrated multichannel platforms enable banks to implement such next-frontier technologies -- when their customers are ready.

Dan Vermeire, SVP and chief technology officer for The Huntington National Bank in Columbus, Ohio, says his bank's IT infrastructure is well positioned to support collaborative technologies, such as instant messaging, voice chat and ad hoc customer video conferencing. "We've got some small-scale chat capabilities in use," Vermeire says. When Huntington's customers demand those features to improve their interactions with the bank, Huntington is prepared to deploy them. "Stay tuned," Vermeire says.

While Huntington is preparing for the future, a small bank in Arlington, Mass., may be ahead of the pack. This spring, Leader Bank ($197 million in assets) began providing its customers with their bankers' AOL Instant Messenger screen names, The Boston Globe reported in an Aug. 12 article. Customers "can ask about anything from certificate of deposit renewal rates to mortgage quotes to information about their accounts," the article said.

Video conferencing, which is in use internally at many banks, also will morph into another customer touch point, many experts say. According to a Financial Insights (Framingham, Mass.) white paper, international banks are beginning to implement video conferencing for specific business purposes. For example, Banco Comercial Portugues (Porto, Portugal; US$95.6 billion in assets) uses video conferencing to discuss complex products with its customers, Financial Insights notes. --N.F.

November 1, 2006 at 07:23 PM in Financial Services | Permalink | Top of page | Blog Home

Fixing the Requirements MESS

Courtesy of NH

CIO | Fixing the Requirements MESS

The requirements process - literally, deciding what should be included in software - is destroying projects in ways that aren't evident until it's too late. Some CIOs are stepping in to rewrite the rules.

READER ROI

* How a broken requirements process can sabotage software projects
* Ways to rewrite the process for success
* Software that can help monitor requirements for problems

Hugh Cumming had his work cut out for him. The gap between what his not-yet-implemented call centre management application at a large European company could do and the requirements list created by 40 eager business-side stakeholders now filled 3000 pages and threatened to delay an already overdue call centre consolidation effort another four to five years. "My first instinct was that the project had absolutely no chance of success," says Cumming, currently CIO for ADP Employer Services Canada.

Requirements, as every CIO knows, are a problem, but CIOs may not be aware of just how catastrophic the problem has become. Analysts report that as many as 71 percent of software projects that fail do so because of poor requirements management, making it the single biggest reason for project failure - bigger than bad technology, missed deadlines or change management fiascos. Though CIOs are rarely directly responsible for requirements management, they are accountable for poor outcomes, which, when requirements go bad, can include: project delays, software that doesn't do what it's supposed to and, worst of all, software that may not work correctly when rolled out, putting the business - and the CIO's job - at risk.

Mishandled requirements can torpedo a project at any time, from inception to delivery. Start down the wrong road and you arrive at the wrong destination. And even if you're heading in the right direction, making fumbling changes midstream can be almost as deadly. Not integrating requirements with your test process can have you racing back late in the game to correct problems that might have been solved early on (and more cheaply).

It's up to the CIO to establish an overall requirements process that works and to support it with the political skills necessary to get buy-in from both the business and development sides. The CIO must also have the organizational backbone necessary to shove wayward requirements processes back into line. None of this is easy. Business users often don't know exactly what they want, can't prioritize what they do want, request things IT simply can't deliver (because of complexity or cost), or can't describe their desires in terms that translate accurately into code. On the IT side, analysts, architects and coders regularly try too hard to please and don't set realistic expectations for projects; they don't use every means possible to guarantee that what they're building is what the user really needs, and sometimes they even fail to make sure that they're talking to all the right stakeholders.

In short, the traditional practice of requirements is broken. But some IT folks are doing everything they can to fix the situation. To a man, they say process is key. Exactly what process? They all have their own ideas. One executive decided to simply enforce rules that should have been enforced all along. Another rewrote the rules from the ground up. And a pair threw out the old rule books completely, one taking a business-process-focused approach and the other choosing to build applications with quick iterations rather than long requirements documents. But they all agree that you should choose a formal requirements-gathering process and stick to it.

Writing requirements is hard. It will always be hard. But with a handful of smart decisions you can create a requirements process that will produce positive results - and maybe keep your next project from becoming another statistic.

Forty's a Crowd

Cumming's solution to his requirements nightmare was radical surgery. First - with backing from ADP's chief executive - he stripped down the scope of the consolidation project, lopping off existing processes that worked as-is and didn't need to be rolled into the new application. He also pared the group of 40 stakeholders to five active participants. He allowed the others to stay involved, but only in the more passive role of reviewing the implementation plan and feature specifications, without actually adding feature requests of their own. He then repeatedly went back to the remaining five stakeholders and asked them if specific requirements were really must-haves or simply nice-to-haves. After less than two months of pressing the issue, his new requirements list was less than 10 percent of the original. And after the project went into production, it needed to accommodate only one major change before being rolled out to 12 global locations.

Cumming says the problem in this case - and in many cases - is that IT often does not take a leadership position in the requirements process, instead taking the attitude that "the business is requesting it, so it must be the best thing to do". But that kind of thinking can lead to requirements lists that are unmanageable and unforgiving. Instead, he says, IT people need to develop a valuable skill: saying no with a smile. "Really what you're saying is: 'Not yet'," Cumming says.

To paraphrase Daniele Vare, managing requirements - like diplomacy - is the art of letting everybody have your way.

When Cumming reduced his army of 40 stakeholders to five, he admits that there were some "interesting conversations" about who would stay in primary roles, noting that people were worried they were going to lose features they felt were important to their business units. To ease their fears, Cumming and the core stakeholders created a "high-level vision" (a summary of the most important functions) for the project and spent time demonstrating how the final project lined up with that vision. He also showed all the stakeholders how they would get at least some value from the project - even if they weren't going to get every single detail they wanted.

The more passive stakeholders were also encouraged to become more active as the call centre system began rolling out. When the system moved into their departments, these stakeholders became directly responsible for sponsoring any necessary application changes within those departments. This task was assisted by the intense interest that senior management had in getting the project into production. Cumming felt he needed to know who really wielded influence in the company (versus what appeared in the org chart), plus he wanted to identify stakeholders with sufficient technical expertise to add value to the requirements-gathering process.

"The list of people who would have the most to contribute to a requirement list always ends up being small in my experience," Cumming says.

The Rules of the Roles

Tired of his company's hodgepodge of requirements practices, Jesse Hanspal, director of development technology services at Bank of Montreal Financial Group, decided to create his own process by combining pieces of existing requirements techniques and adding a quality assurance process as well. Hanspal says that after five years of effort, the bank has defined the requirements process at a level of abstraction high enough that it can be applied to any project or problem. After much consideration, the bank decided that it needed a process built around responsibility and job roles in order to guarantee that all necessary stakeholders had a say.

"It's important to get all the stakeholders around the table and get the requirements from the horse's mouth," Hanspal says. And, he adds, by defining stakeholders according to their roles, you get a more accurate cross-section. For instance, he says, for a given project, you need representation of the end-user role, of course, but also of the application administrator role, not to mention roles related to security and regulatory compliance.

Hanspal notes that in the past IT spent 10 percent to 20 percent of its time and energy on defining requirements. "What we've learned is that once you have defined a process, then you go and get an ISO 9000 certification for that," he says. Having the certification lets people know what is required of them. It also gives the bank a chance to evaluate effectiveness and improve the process. And Hanspal says the new process has produced results. For instance, the number of software defects related to requirements has dropped by some 50 percent since implementing the new controls.

Bank of Montreal also wanted to make sure that its analysts had the skills necessary to execute the new process. Unfortunately, while it had been easy to find external certification for project management (the Project Management Institute) and functional testing (the Quality Assurance Institute), no similar body existed for business analysis. So the bank created its own. The International Institute of Business Analysis now boasts some 800 international members, Hanspal says, and any company can send analysts for training in the Bank of Montreal approach.

Going Agile

Given the trouble companies continue to have with requirements, some practitioners argue that the process needs to be more flexible.

Gregor Bailar, CIO at Capital One, is a convert to one of these antiestablishment philosophies: agile development. Agile development advocates argue that old-style requirements processes are too rigid, put walls between users and developers, and, given the ever-changing nature of software and business, are fated to fail. Instead, they say, developers and users should sit down together and start coding almost immediately, stopping frequently to evaluate progress and make necessary changes based on user input without feeling the need to follow a monolithic requirements document. (For more information on agile development, see "Code of Practice", CIO May 2004.)

"What we needed wasn't more process but to get to the value [in a project]," Bailar says.

After piloting the concept in early 2004, Bailar began forming the ultra-lean, connected teams that are the basis of the agile method. Agile teams at Capital One generally consist of three businesspeople, two operations people, and five to seven IT folks, including a business information officer (in effect, a translator who works between the business and IT sides), a project manager and at least one of the 80 developers that Bailar sent to formal agile training classes. Along the way, some architects and security experts will add their skills as necessary. Each team gets its own agile coach (one of 20 Bailar hired) to keep an eye on the proceedings and offer advice and support. Teams meet in dedicated, open rooms, and initial requirements are limited to a goal for the project, a handful of cards with specific needs, and some models or prototypes for reference. Teams work together in close quarters throughout the project, and development stops regularly - perhaps three or four times in a typical nine-week development cycle - to assess progress and determine if changes are needed. Larger projects are built by breaking projects down into small pieces and assigning each subsection to an agile team (the method is sometimes called "swarming" in agile circles), with the overall progress controlled by a project manager.

To test the results of the system, Bailar took several in-development projects and switched them midstream from older waterfall-style development to "scrum", an agile technique that prescribes small, flexible groups that include developers and users and divides development into a sequence of 30-day "sprints". These sprints begin with a planning meeting and end with the group reviewing test results before the start of the next sprint.

He then tracked their progress against the historically expected progress of the older method, and he was happy with what he saw. Agile reduced development time by an average of 30 percent to 40 percent (sometimes nearer to 50 percent) while simultaneously improving the quality of the deliverables. He's sold, though he acknowledges that agile has its limitations.

"There are lots of things we don't use agile for," Bailar says, noting that the method excels where requirements are ambiguous and priorities are unclear, or for situations where you have the triple constraint of "faster, cheaper, better" but can't afford to drop one of the three. For extremely large projects or those with very distinct and ordered requirements, Bailar says more traditional approaches are probably a better fit.

Every Line of Code Connected to a Business Process

Robert Sherman might not see it that way, however. Sherman, the strategic methods leader for IT at Procter & Gamble Pharmaceuticals, isn't a huge fan of traditional approaches to requirements. He considers requirements only one of the first threads in a tapestry that includes everything from business processes to a finished software application. And unless IT managers begin to realize the importance of this interconnectedness, he warns, countless projects will continue to crash and burn.

Like ADP's Cumming, Sherman had a requirements epiphany in the late 1990s. At the time, he was involved in an effort to standardize all of P&G's 150 factories on a single factory-floor information management system. He and nine other experts at the company compared a 70-page specification written by the supplier to a 200-page requirements document written by P&G. Experts and vendor alike agreed that the document contained everything necessary for a successful project. It was concise. It was complete. It also "went to hell in a handbasket", Sherman says.

Poking through the rubble, Sherman at first couldn't understand what had gone wrong. Why had the seemingly ideal specification failed to produce a suitable application? He hired a contractor who spent two months tracing every requirement to every relevant sentence in the specification. P&G found that 30 percent of the deliverables were not adequately addressed. And from what Sherman could tell, the misfires were a result of being too dependent on team members' recollection of document comparison. The supplier had looked for common patterns that it could duplicate in order to reduce coding complexity. To Sherman and the others reviewing the specification, it looked - on the surface - as if those patterns matched exactly to the requirements. But they hadn't. The problem, Sherman eventually decided, was that everyone involved had simply run up against the limits of their ability to comprehend extremely complex situations. The management tools they were using were also unable to make proper connections between deliverables and the actual business processes they would support - connections that would have highlighted the subtle distinctions that turned success into failure.

Frustrated with the inability of requirements management software vendors to address the overriding disconnectedness he felt was at the core of many development problems (not just this one), Sherman decided to build a system using his own schema and a collection of tools that now includes Visio and Telelogic's Doors. The premise, he says, was simple: granular traceability. His vision was to be able to take a piece of code and quickly trace it back through the development process, back to requirements and then - rather than stopping there - map it all the way back to every affected business process to better gauge the application's impact on the business and to find hidden stakeholders.

Getting to this point has taken five years and has required the IT team to gain an encyclopaedic understanding of business processes, but the results have been worthwhile. Using complex pharmaceutical project lifecycle management tools as a benchmark, Sherman says he produced the application at one-quarter the cost and with fewer than 10 percent of the expected defects compared with outside development estimates. Sherman also helped another group in P&G apply the technique to a teetering ERP implementation that seemed destined for failure thanks to a never-ending requirements process. By shifting midstream to the new schema, however, the project got back on track and now looks like it will be a success, he says.

The P&G schema has produced numerous side benefits as well, Sherman adds. For instance, an approach called "initiative scenarios" helps IT teams identify potential enterprise-level stakeholders, with the aim of converting them to sponsors before a project even gets under way. Since every requirement links back to a business process, business-side stakeholders, developers, architects and analysts can trace their way through the organization, identifying groups that feel an impact from the new application, even if they weren't the actual end users. As an example, Sherman points to an Electronic Lab Notebooking (ELN) application (a digital data collection tool for researchers) that P&G had been having trouble getting rolled out. Previous attempts at justifying and delivering the ELN limited the requirements analysis to the lab bench and the scientist who used the notebook. But Sherman was able to demonstrate a domino effect that showed how notebook data would affect acquisitions, divestitures, patent filing and more. As a result, the IT group was able to seek additional sponsors inside the organization, and the project is heading toward 4000 users.

"If you've done the appropriate joins [to these work processes] and you understand the linkages back to the roles, you can get the clearance ahead of time - or kill the project if you don't have the buy-in," Sherman says.

The schema also has a dramatic impact on compliance. A too-restrictive view of regulatory issues can cripple projects in the pharmaceutical industry. A too-loose interpretation, meanwhile, could open the company to legal action. But previous requirements methodologies at the company relied more on gut instinct to determine the proper balance. Now, Sherman says, compliance experts can trace their legal requirements all the way from business process to final code to determine if regulations come into play. And the schema's chart-like format and standardized sentence structure make it possible for just about anyone to trace a path, which helps users and developers prioritize requirements

based on which ones will have the greatest impact on a business process.

Even so, Sherman says, successfully using the schema requires a couple of rules. Projects must be broken down into pieces. More complex applications can be built by combining these pieces, but Sherman believes that going beyond a certain level of documentation leads only to more documentation - and greater complexity - instead of execution.

Required Thinking

As these cases show, requirements processes must change, and CIOs need to drive the charge. Fixing your broken process probably won't be easy or quick, so start now.

"Today, survival depends on game changing - certainly for IT it does," P&G's Sherman says. To change the development game, "IT is going to have to understand the intersections between requirements and business processes". Failure to achieve that understanding could have dire consequences, he warns.

"If you're not rewriting the rules of the game," Sherman says, "then you deserve to have your job offshored."

SIDEBAR: REQUIREMENTS TOOLS

Guardrails to a Good Process

Tools never fixed a software problem, says Richard Chennault, enterprise architect at Kaiser Permanente. But when it comes to managing the requirements process, tools can be a help - assuming good processes are already in place.

Whether you subscribe to the Rational Unified Process and own the complete suite of Rational applications or simply piece together your own toolset from smaller vendors such as Borland and iRise, tools can act as bearings and guardrails to help keep your requirements process moving and on track. Some examples:

• The Framework for Integrated Test (FIT), developed by Ward Cunningham (who also invented the community-edited online Wikipedia), is a platform where requirements are literally written as tests - for a requirement to be met, the test must pass. And FitNesse, which puts a wiki-like interface on the FIT methodology, allows business users (or more likely business analysts) to enter requirements into a spreadsheet interface that automatically produces test cases for later testing.

• Sofea's Prophesy (used by Bank of Montreal) lets customers and business analysts produce simulations and tests before any code gets written.

• SteelTrace Catalyze (used by ADP) is a requirements-management tool that breaks requirements into functional and non-functional (qualitative) buckets, creates graphical storyboards of requirements and generates test documentation.

• Telelogic's Doors (used by Bank of Montreal and Procter & Gamble) integrates with Mercury Interactive's TestDirector for automated testing.

• iRise's iRise Studio lets companies create rich prototypes of applications, allowing, if not functional tests, at least visual confirmation that requirements are being accurately modelled. Short of having a simulation, you will get to the testing phase and have misrequirements, says David Nix, vice president of online banking at Suntrust, an iRise user.

• Borland CaliberRM allows simplified requirements modelling.

But, while all these products can simplify the requirements in your life, you have to focus on process first, says Chennault. You can do all this stuff with a notepad and a pencil if you have a great process.

October 14, 2006 at 02:33 AM in Financial Services | Permalink | Top of page | Blog Home

As good as it gets? Banking in UAE

Banker Middle East - The business of banking

The United Arab Emirates is home to some of the region's most successful banks, but are there too many of them? Robin Wigglesworth examines where the opportunities lie for retail and commercial banks in the UAE, and whether consolidation is the panacea for an overbanked market

If anyone thought that the volatile stock market would put a damper on the record profits of banks in 2005, they were sorely mistaken. Though much of the profits of UAE banks can be attributed to the booming markets, their underlying performance seems to be stronger than many analysts fear, with many banks reporting excellent first quarter results in 2006.

According to a recent report by EFG-Hermes, an Egyptian investment bank, the massive oversubscription of two IPOs that closed in March "severely distorted" the first quarter balance sheets of UAE banks. However, the only bank that posted negative earnings growth compared to the same period in 2005 was National Bank of Dubai (NBD), and this was only because of the one-off sale of its investment securities in early 2005.

This is heartening for the UAE, which has often been accused of being bloated with banking institutions, with 21 locally-incorporated banks and 26 foreign banks servicing an estimated population of 4.3 million.

There are historical reasons for the current overbanked situation. For a long period, the UAE was not a single banking market, but rather a conjunction of many micro-markets. Each Emirate was keen on keeping a bank in its own jurisdiction, fearing that the larger institutions would not be keen on having branches in the peripheral areas that were economically weaker than the financial powerhouses Abu Dhabi and Dubai.

"THERE IS CERTAINLY A STRONG CASE TO BE MADE IN FAVOUR OF SOME MERGERS IN DUBAI AND ABU DHABI, THE TWO LARGEST SUB-MARKETS."

With a few scattered exceptions have been very few institutions that have focused on a pan-UAE reach, and concurrently, there has been a willingness by local governments to maintain a bank in each Emirate.

Furthermore, after the Lebanese civil war, Bahrain and Dubai both competed to become the regional banking centre, and opened up to many foreign banks. The largest foreign banks, such as HSBC and Standard Chartered, now even compete with the top five local banks.

The influx has now stopped, as the Central Bank of the UAE has correctly deemed that 47 banks serving such a small population is not sustainable. However, according to Anouar Hassoune, an analyst for Standard & Poor's, competition has remained very strong, because overall, the UAE is" a market that provides banks with tremendous opportunities in private banking, asset management and investment banking, not only because of Abu Dhabi's oil wealth, but also because of the Dubai experience".

Atif Bajwa, head of the retail banking group at Mashreqbank, admits that the UAE is "a small market", and given the number of banks involved in retail, a call for consolidation would be "justified". The population centres are few, and according to Atif, they are "well-branched and have a very high density of ATMs".

There is certainly a strong case to be made in favour of some mergers in Dubai and Abu Dhabi, the two largest sub-markets. In Dubai, the government directly and indirectly controls NBD, Emirates International Bank and Dubai Bank, just in the conventional space. In Abu Dhabi, the government and Abu Dhabi Investment Authority (ADIA) control both NBAD and Abu Dhabi Commercial Bank (ADCB).

Anouar says Standard & Poor's expects to see more consolidation of banks, particularly for those that it makes "no economic sense to have them as separate entities". It is certainly true that regional competition will increase and shareholders will eventually realise that size does matter. With a larger pool of assets and capital, banks would be able to finance larger projects, have a wider branch network, and establish new initiatives such as private banking or Islamic finance subsidiaries.

NBAD has recently noticed the cost of such ventures. Whilst it is the largest bank in the UAE, it is, as Michael Tomalin, CEO of NBAD admits, "relatively small" in global terms. "It costs a tremendous amount to set up all these ventures and subsidiaries," says Michael, "whether private banking, Islamic banking or even having an office in London or New York. All this has very high fixed costs, and you need a very strong base at home in order for the economies of scale to work for these new ventures."

And the bottom line is that mergers cut operating costs, and enable banks to compete on pricing to attract more customers.

The case for consolidation is seemingly rock solid, and has been so for some time, but there has been no true M&As since the 80s, when ADCB and Emirates Bank were formed from a merger of several banks. Michael has felt "quite strongly for some time that consolidation should come", but says it is"not very high on the agenda right now". Why?

The key driver for consolidation is a desire to increase the return on capital, and mergers generally shave costs and have revenue uplift possibilities. However, as long as profits remain as high as they have been recently, there is little pressure on the banks to cut costs by operating on a larger scale. "Return on capital is good right now, and is likely to stay that way for some time," says Atif.

As of today, even small banks such as Sharjah Islamic Bank and RAKBank are performing well, having found their niche market. Atif says competition from the "smaller, nimbler" banks has become "quite intense" over the past few years, and RAKBank, for example, has pursued an aggressive marketing campaign aimed at the middle income mass market, and come up with a series of interesting products, according to Atif.

Sharjah Islamic Bank (SIB) is another case in point. National Bank of Sharjah was said to be doomed either to be subsumed by a larger entity, or continue trooping on, with little possibility for growth or expansion. However, it identified a previously niche market, Islamic banking, teamed up with Kuwait Finance House (KFH), giving up 20% of the shareholding in return for a management contract with KFH, and converted completely into an Islamic bank. A good example of what effect the conversion has had is to look at the share price. Before the conversion, National Bank of Sharjah traded at AED 3, but SIB is now traded at around AED 13.

"YOU COULD END UP WITH A CROSS-BORDER CONSOLIDATION OF A UAE BANK, ENTERING A REGIONAL NETWORK."

It is by most measurements an outstanding success story, and one that is likely to be emulated by other banks. Dubai Bank, for example, has already announced that it will be converting to become completely Shari'ah compliant.

However, consolidation among UAE banks could happen as a result of two scenarios. Firstly, intense competition might force the hands of banks unwilling to be subsumed at this time. The UAE market cannot continue to grow indefinitely, and to expand their market share, banks will have to compete more aggressively on pricing than they do now. As in all markets, this will weaken the small institutions and strengthen the larger ones, and a small bank might be forced to seek a merger.

Secondly, consolidation might happen if banks realise how costly organic growth can be. The current boom and expansion of banks across the Gulf means that competition for human resources is fierce, and shareholders might be willing to trade some control for scale.

Morgan Stanley has more experience with mergers and acquisitions than most, and is likely to be at the thick of things should consolidation happen. Dr. Georges Makhoul, regional head of Morgan Stanley's Middle East and North Africa office, strongly believes consolidation among UAE banks will eventually happen, not because of a need for higher capitalisation, but "because the competition for places to invest is going to get harder and harder".

However, he stresses the need for thinking out of the box, rather than a simple consolidation of, for example, the Dubai government's shareholding in UAE banks. "You could end up with a cross-border consolidation of a UAE bank, entering a regional network".

Another possibility might be a Saudi bank entering the UAE market by buying RAKBank or other small to mid-size institution. They could then, thanks to abundant Saudi capital, grow organically across the UAE. Georges is "certain" that Saudi banks are interested in buying other GCC banks, and says that whilst the time is not right yet, "the structure is there, and they will do it". Anouar says it is "merely a question of speaking to each other", and with the continuous flow of financial conferences and official government meetings, it might be only a question of time.

Opportunities
So far, the primary focus of UAE banks has been on serving the affluent segment and the upper middle class, in particular the large civil service. However, there are still abundant opportunities in this and other customer segments. Whilst locals have been well-served, the large affluent expatriate population is, according to Anouar, still "underserved" by domestic banks.

Despite intense competition, there is still a huge pool of potential clients for private bankers, but local UAE banks have been slower in focusing on this segment than the large foreign banks, a fact that Michael is very aware of. "The percentage of the business with local banks is relatively small, and the overwhelming majority of it is with the international banks. This is something we would like to change." Private banking services at local banks tend to be priority deposit and loan service with a relationship manager, whilst the asset management and wealth advisory business has often been left with the international banks due to the lack of skill sets at local banks.

Atif feels that financing for small and medium sized enterprises (SMEs) and commercial banking has also been neglected by UAE banks, but maintains that this is now changing, and the market will soon see a series of initiatives and products from leading UAE banks.

The rush of banks such as NBAD, First Gulf Bank, Union Bank of Abu Dhabi and Mashreqbank to establish Islamic finance company subsidiaries after the Central Bank approved new regulation, and the success of Emirates Islamic Bank and SIB, indicates the strong potential of Islamic banking. However, whilst the potential of Islamic finance in the UAE is undeniable, the Islamic finance companies are limited to what they can do in the retail space.

"THE MORTGAGE MARKET, AND INDEED THE WIDER RETAIL CREDIT AREA, IS ALSO DEPENDENT ON THE ESTABLISHMENT OF AN EFFICIENT CREDIT AGENCY."

It is the mass retail market that has been ignored the most. According to Anouar, there are very few banks across the GCC that concentrate on the mass market, and "none in the UAE". Banks have understandably focused on the high earners, but astute banks should diversify their deposit base to include this mass segment. A large UAE bank should have the right tools to manage the risk on a portfolio basis, and consolidation would again allow a bank further to neutralise any risk involved with the mass market segment.

Mortgages are a staple banking product in almost any other market, but not among UAE banks. However, that trend is changing, with a flurry of banks entering the mortgage market, ready to take advantage of the opening of the property market and the vast amount of homes ready to hit the UAE market.

Anouar says that mortgages are the "next big thing" for banks, but adds one large caveat: The legal framework for property ownership in the UAE is inadequate. "It is not supportive of banks that want to foreclose on loans and seize collateral. Atif agrees, pointing out that whilst the mortgage market is "relatively new and immature", the implementation of a comprehensive legal and regulatory framework would be "a great boon" for the industry.

The range of mortgage products is still incomplete, and repossession, the basic concept underpinning mortgages, is still untested in the UAE. In many ways, this is due to the particular cultural characteristics of the Middle East. One of the most basic principles of Islam is that you cannot evict a family out of their home, so repossession by a bank is an anathema, not only to Islamic banks, but to the entire culture of the country.

Therefore, the mortgage practices of the west will probably not be directly copied in the Middle East, but as Anouar points out, Islam itself might offer the solution through the concept of Ijarah, where the bank owns the underlying asset itself and leases it to the customer. If the customer defaults, it becomes a question of how to settle losses and assets between the parties. It will need work, but the banks are on it, and don't put it past them to come up with a product that serves both the banks' need for collateral and the customers' need for a home.

The mortgage market, and indeed the wider retail credit area, is also dependent on the establishment of an efficient credit agency. According to Anouar, an agency is "necessary" for the further development of the mortgage market, but says it is difficult to establish if it is not managed by the Central Bank. Atif also calls for the active involvement of the Central Bank, which he says should "push the establishment of a central credit bureau to develop a robust and sound retail credit environment".

However, due to the federal structure of the country, the Central Bank of the UAE is weaker relative to other GCC regulators, so UAE banks now have to do it themselves. Government involvement is vital, as credit agencies are useful when everyone is part of them, but each individual bank has very low incentives to take part.

October 10, 2006 at 12:52 AM in Financial Services | Permalink | Top of page | Blog Home