The year 2015 marks the tenth anniversary of peer-to-peer (P2P) lending. Zopa was launched in the U.K. in 2005, a time when unsecured borrowers were paying more than 15% per annum and bank depositors were earning 5%. Zopa matched borrowers and investors with materially better terms via an easy-to-use Web interface. In June 2005, investors lent £45,000 via the Zopa site; June 2015 saw nearly £45 million of new loans via the same site.
It was quite a personal affair in 2005 — borrowers chose their own usernames, could write a short message explaining their borrowing needs and could even write a thank you note to lenders when the deal was done. For investors, it was more complicated than today. Investors chose from a number of risk categories and maturities, could choose their maximum loan size and post their target interest rate. The site advised investors as to whether their rate was in the “zone of possible agreement,” explaining that rates outside the “zopa” would result in funds being invested at a much slower rate.
Today’s Zopa lenders only have to choose one of two maturity bands and state whether they want repaid funds to be automatically re-invested. Zopa limits an investor’s maximum exposure to any one borrower to ensure diversification and has a first loss facility, which, although not guaranteed, has covered all losses on eligible loans since its launch two years ago.
The Zopa story has been repeated hundreds of times around the world and has extended from consumer unsecured lending to small and medium-sized enterprise (SME) lending, factoring, mortgages and student loans. The role of the “peer” has diminished as institutional investors now dominate the lending, and an increasing proportion of borrowers are SMEs. The alternative name for this sector – Marketplace Lending (MPL) – is therefore more appropriate. The advances in automation and ease of use seen on Zopa’s site have also been mirrored elsewhere with later entrants trying to distinguish themselves using innovative features. However, since the foundations of MPL are built on financial technology, or FinTech, innovations on one platform can be quickly copied by others in ways that the banking sector, mainly operating from legacy systems, can’t match.
Collaborate or compete?
It is the contrast with the banking sector, as much as developments within the MPL ecosystem itself, that interests MPL observers, bank analysts and policy makers. Part of the interest is whether banks and MPLs will collaborate or compete and how the financial performance of each could evolve, but much of the interest is motivated by a genuine need for more lending, particularly in the SME space, to keep the world’s economic recovery moving. Those focused on the latter are less concerned with the structural outcome so long as the result – more lending – is achieved. Those focused on the former have a near-term interest in the investment opportunities associated with a FinTech boom and a longer-term interest in how this could change the profitability of the banking sector. For them, the structural outcome is crucial.
The spectacular growth in lending volumes seen within the MPL sector sends out a very strong message. However, over the last year there has been a noticeable increase in the announcement of strategic partnerships between MPL sites and credit originators; the focus has shifted from finding investors to sourcing origination. Bottom line: the MPL market is finding it harder to originate new loans in order to keep up the growth rates that the industry now seeks. Much of the low-hanging origination fruit has been picked; the MPL market now has to address the reality that most consumers and SMEs don’t log on to a Web browser when they need to borrow.
Deep wells
One of the most obvious sources of origination is, ironically, the banking sector itself. The U.S. and European banking sectors have total assets easily in excess of $30 trillion and continue to see headwinds from de-levering, higher capital and liquidity charges, with management averse to risk-taking. If the MPL markets in Europe and the U.S. could gain access to just a tenth of 1% of bank balance sheets, their origination would roughly double.
The collaboration between banks and MPLs is, therefore, perhaps the most exciting development to monitor over the next few years. It is also more complicated than meets the eye because there is real economic benefit for banks to actively collaborate with MPLs. Passive collaboration takes the form of banks slowing down their lending to consumers, SME, students and the mortgage markets and allowing MPLs (and others) to pick up the slack. Active collaboration is where banks effectively partner with alternative lenders such as MPLs to separate risk from relationship. If banks could enjoy the fee-earning potential of a client relationship without the associated balance sheet and capital cost, the profitability of banks could be transformed.
This isn’t, in itself, a revolution in banking. The appearance of the corporate bond market is a good example of splitting risk from relationship and it makes complete sense in a world where many of the funding needs of borrowers are exactly met by the lending needs of investors. Put another way, just because banks offer the ability to transform risk, liquidity and maturity doesn’t mean that it’s always necessary. Arguably, the transformation services of the banking sector should ONLY be used when they are needed. There is a cost to this service and, where possible, it should be avoided. The economic benefits are clear, as are the systemic risk benefits of a smaller bank sector.
Not going away
The users of P2P Lending in 2005 could never have guessed how the market would have grown as well as evolved over the next 10 years and making predictions for the next 10 years is no easier. Nevertheless, a few things are certain. The first is that MPL is here to stay as it genuinely adds value to the process of originating, risk assessing and distributing consumer and SME loans. Secondly, MPL is not going to displace the banking sector, it’s going to complement it. How big a share of the origination pie it grabs is uncertain, but with all parties involved benefiting from a shift from bank balance sheet to MPL balance sheet, it seems likely that the shift will be significant.
Doubtless these topics and others will be hotly debated this fall at Crowdfinance 2015: The Evolution of Global Marketplace Lending on Sept. 28 in New York City.
Robert Reoch is Global Head of Products and Strategy at Crowdnetic.
Receive stories like this to your inbox as they are published. Subscribe here and follow us @Alpha_Now on Twitter. If you are looking to access our data or analytics, register for a free trial.
