The Decade Disrupting Financial Relationships

Just imagine you’re ready for an economic growth venture — be it kickstarting a business, homeownership, investing into a company, or snagging that shiny new purchase. You probably go to a high street bank to take a loan, and build a lender-borrower relationship, which might last for decades. What if this lender-borrower relationship causes more headaches than benefits? What might be the human centred approach to financial relationships?

There is a silent trend around the globe, redesigning the lender-borrower relationship as an investor-investee relationship. You might think these two are irrelevant financial relationships. Let’s look into how lender-borrower relationships works, how investor-investee relationships works, and how investor-investee relationships create a better future.

THE LENDER BORROWER RELATIONSHIP

The lender-borrower relationship roots back to the 17th century. Goldsmiths in London began to offer deposit accounts to people, who could deposit their gold and receive a paper receipt in exchange. These paper receipts helped people to transact without having to carry physical gold. Goldsmiths realised customers rarely come back to withdraw their gold deposit. So they started to lend out some of the gold deposited and earned income. This practice became known as fractional reserve banking, as banks hold only a fraction, 1/10 of their customers’ deposits in reserve, while lending out 10/10. For example, a bank holds £1 of tangible value in reserves and claims £10 in deposits. They create £9 fractional money, just with a click, and lend the total £10 to earn income.

Here is how it works:

1. Lenders’ profits depend on creating and lending as much fractional money as possible to earn more interest.
2. This means lenders use money as a value (interest) rather than just a medium of exchange. Success doesn’t depend on economic growth for borrowers but on the interest payments to the lender.
3. The more fractional money lenders create to lend, the more inflation occurs, eventually causing the value of cash to decrease and the cost of physical value (gold, onions, houses, etc.) to rise.
4. What’s more, the movement of this fractional money in markets manipulates the prices of physical values (gold, potatoes, houses, etc.) overnight, although their quantity doesn’t change.
5. In the long term, each new generation’s purchasing power decreases until borrowers prefer not to borrow, preventing the creation of fractional money by lenders.

Summary, the lender creates fractional money and earns money from money without getting exposed to the risk of the borrower with their new economic growth venture.

“If you are living in a no-growth economy and somebody can give you 12, 13 per cent with almost no prospect of loss, that’s about the best thing you can do.” — Steve Schwarzman, Blackstone Founder

“Money is essentially free for those who have money and creditworthiness, it is essentially unavailable to those who don’t have money and creditworthiness, which contributes to the rising wealth, opportunity, and political gaps.” — Ray Dalio, Founder of Bridgewater Associates

THE INVESTOR-INVESTEE RELATIONSHIP

The investor-investee relationship has been there since the beginning. People share the risks and rewards of a new economic growth venture. In this way, both the investor and the investee have skin in the game; they have to get to know each other (due diligence), collaborate, and do their best — whether it’s finding resources like fruits, exploring a space mine, attempting to launch a deep tech venture, or creating homeownership for a family.

Here’s how it works:

1. Investors’ profits depend on identifying and investing in people who have an economic growth opportunity. They become partners, not lenders.
2. This means investors use money as a medium of exchange to buy equity in the economic growth opportunity. Success depends on the economic growth opportunity pursued together.
3. The more investments made, the more risks and rewards are shared within the economy. More social interactions occur between investors and investees, leading to a better distribution of money (from credit worthiness of borrowers to anyone with an economic growth opportunity).
4. Furthermore, the price of physical value is not manipulated by fractional money created but by the valuation of economic growth opportunities. It’s a free market based on willingness to pay.
5. In the long run, each new generation is inclined to be an investor or investee to create new economic growth, which fosters a more social and productive economy.

Summary, investors and investees share the risk and reward of an economic growth opportunity, leading to increased collaboration, trust-building, and opportunity-seeking among people.

“The entire ecosystem stays on because the value is in bringing everyone together. That’s the magic.” — Andrew Chen, The Cold Start Problem: How to Start And Scale Network Effects

Summary of differences of lender borrower and investor investee relationships.

Let’s look into where we have some of the biggest financial relationship by size and how they are redesigned as investor-investee relationships:

1. COMPANY BUILDING

You might already be thinking of Silicon Valley and the emergence of venture capital as a prime contemporary example of the investor-investee relationship. Trillions of dollars in economic value could not have been created through lender-borrower relationships:

“Only a fraction of 1 percent of firms in the United States receive venture backing. But in a study covering the quarter century from 1995 to 2019, Josh Lerner and Ramana Nanda find that VC-backed companies accounted for fully 47 percent of U.S. nonfinancial IPOs… Thus, even though VC-backed firms accounted for 47 percent of IPOs, they accounted for 76 percent of the market value at the end of the study. They also accounted for 89 percent of R&D spending.” ― Sebastian Mallaby, The Power Law: Venture Capital and the Making of the New Future

2. COMPANY FINANCING

What if you do not want investors as new shareholders, but also do not want to be a borrower?

Cordova Capital Markets offers an alternative to the lender-borrower relationship. They raise working capital through profit participation notes, allowing companies to fund specific activities while sharing profits with investors. Investors contribute to financing activities, such as buying raw materials like cacao. The company processes the cacao, sells the chocolate, and profits are distributed among investors. This model allows for transparent investment in specific activities, preventing issues like greenwashing or fraud. Ultimately, it enables people to invest in activities they genuinely believe in and want to support, rather than simply lending money or buying stocks. In a sense, investment is becoming hyper personalised and activity based, much faster and accessible.

“Until you make the effort to get to know someone or something, you don’t know anything.” ― Ben Horowitz, The Hard Thing About Hard Things

3. ASSET OWNERSHIP

Real estate, the world’s largest asset class, is quietly being redesigned. Take Divy, for instance. It facilitates an investor-investee relationship, allowing you to choose a home. They buy it, and you contribute 1 to 2 percent of the selling price (cheaper than a traditional down payment). This amount forms a fund for your future down payment. You then rent the property at market rate for around three years, with 25% of the rent going into a down payment nest egg. Eminevim in Turkiye enables people to pool resources and become homeowners through housing draw groups. Withco is a platform for small businesses to co-own commercial properties, converting rent expenses into wealth. Flow, though not yet launched, introduces a novel rent-to-own model, allowing renters to build equity without location constraints. With these homeownership models we can start discussing housing as a right rather than an asset to profit and earn interest from.

WHAT IF BANKS ARE…?

HSBC’s acquisition of Silicon Valley Bank UK and its transformation into HSBC Innovation Banking showcase their ambition to take on an investor role for the venture ecosystem in the UK. They aim to offer innovation expertise, cross-border finance capabilities, and leverage their global presence as a go-to-market channel. Many banks are actively seeking new models, moving away from lender-borrower relationships. At this juncture, embedded finance has gained momentum, with financial institutions transitioning into technology providers for non-financial companies. The success of a bank becomes directly linked to the success of the companies they provide embedded finance to, creating a win-win situation for all by enhancing the end consumer experience.

While the financial services landscape is vast, the trend persists: banks are shifting from their traditional lender archetypes to becoming active investors, presenting tangible offers for new economic growth ambitions. With less fractional money and an increasing number of investors, we are poised to witness the rise of more investor-investee relationships in society.

In this exploration of financial relationships and their impact on economic growth, we find ourselves at a crossroads of traditional lending and a transformative shift towards investor-investee dynamics. The historical roots of the lender-borrower relationship reveal a system designed for profit through fractional money creation, detached from the true essence of economic growth. On the other hand, the emerging investor-investee relationship redefines success as a collaborative pursuit of shared opportunities, fostering a more social and productive economy.

To all the human centred design practitioners transforming or disrupting the financial sector; which one feels right to you?