Peer-to-Peer Lending
The cost of capital conundrum
Peer-to-peer (P2P) lending platforms have been around for a few years now, but have not been terribly successful. On paper, it is a fantastic idea: Here's a mechanism that connects borrowers (say, businesses looking for working capital loans) to lenders (individuals looking to earn an interest on their savings). Sounds simple, just like Uber. A platform that does not depend on the traditional financial institutions -No bank branches, no sales agents. It provides easy online access for borrowers, at potentially lower rates & attractive returns for lenders.
US-based Lending Club, founded in 2006, was probably one of the earliest entrants in this space. Lending Club's USPs for borrowers were: low interest rates & more flexibility in loan terms, as compared to traditional banks. After the very initial success, came a point where there were many borrowers lined up for that value proposition (many of those, surely sub-prime) & not enough lenders. A retail lender on the platform had no recourse to go after a defaulting borrower, and honestly, this guy was comparing this unsecured loan, with other investment opportunities with far lower risks for a similar or slightly poorer return. So when this retail lender stopped showing up on the platform, Lending Club needed alternate sources of capital to meet the demand for loans. Gradually it started relying more & more on traditional financial institutions for this. What does that mean? It was simply re-selling the banks’ loan products. The percentage of institutional lenders at Lending Club was approximately 1% in 2012 & this percentage increased to 48% by 2015. Shortly after that, hedge funds & venture capital funds entered the space as buyers of Lending Club’s loan portfolios. Eventually in 2020, Lending Club acquired Radius Bank & with a full banking license announced that it would be shutting down its peer-to-peer lending platform. Lending Club re-positioned itself as a 'market place' lending platform where borrowers were matched to institutional lenders. As a result, it stopped about $ 20 million revenue a year from leaking from its revenue pool to the financial institutions.
China saw a big boom in P2P business lending in the early 2010s too. Banking services are rather tightly regulated in China, and deposit rates for retail savers were very low. This lured many individuals to lend on P2P platforms. Many dubious platforms & duped lenders later though, the government announced regulations in 2015 requiring platforms to maintain a deposit with a commercial bank and register the platform with the regulator. With this, even the legitimate platforms lost their competitive edge of having low-cost access to capital.
On average today, around 50% of P2P loans worldwide are funded by institutional investors such as banks, pension funds, investment firms, or insurance companies. In the US, that percentage is as high as 85%. So if the capital is raised by either partnering with a bank, or securitisation of the loan, why wouldn’t a borrower cut the middleman & go directly to the bank? Where exactly does the competitive edge for these lending platforms lie?
The user experience, is one important differentiating factor. There are platforms sharp-focused on the user experiences around student loans, entrepreneur loans or on point of sale loans. I will be doing separate pieces on some of these stories. Not having to manage overhead costs (such as the cost of maintaining a branch network, or clunky compliance teams) could be another differentiator. The efficiency in disbursing loans & client acquisition may be the third.
Having said that, there are two things that remain key:
Having access to capital with a cost equal to that of large banks (and remember, banks raise capital from depositors looking for safety & who accept very low interest in return),
and
Maintaining a high quality of the loans i.e. not relying solely on borrowers who have been rejected by the banks as being too risky
Have you used one of these platform either as a lender or a borrower? What has your experience been like? Do share in the comments!