Many markets are being disrupted by peer-to-peer (P2P) connectivity and new open marketplaces. Think Uber for taxis and Airbnb for hotels. These are the new marketplaces for personal transport and accommodation. Some say that P2P lending is the new marketplace for financial credit. From mortgages to trade finance to personal lending, P2P crowdfunding is changing the game, but I contend that it is not disruptive at all. Instead, it is just a shift from traditional institutions funding consumers and businesses to a new form of risk mitigation through an additional third-party layer.
I’m often asked whether it’s too difficult for an incumbent bank to adapt and change to the 21st century digitalization challenge. It’s certainly difficult if you have to rip out core systems, reorganize the whole bank, and rethink everything while keeping the existing organization running. That’s why a number of banks are launching new banks. But there are other strategies. I’ve blogged quite often about banks that are incubating, escalating, and investing in fintech, yet that is also a flawed strategy as it gives the bank a stake in a new potential unicorn but it doesn’t change the bank.
Then there’s another strategy that’s starting to emerge which is to view those who are disrupting as risk partners. This is certainly the development that began in the U.S. after regulators stopped the rise of P2P lending. In fact, it’s interesting to see how the P2P lending markets have diverged between the U.S. and the U.K., two of the biggest marketplaces for such markets alongside China.
The U.S. regulated American peer-to-peer lenders back in 2008 such that they must conform with U.S. securities regulations. What does that mean? It means that peer-to-peer lenders are not actually lending peer-to-peer. What they are doing is buying a promissory note from the marketplace platform – e.g., Prosper, Lending Club – and that note obliges the marketplace to repay you as long as individual borrowers pay back the loan. If they don’t pay back, the investors lose.
This was viewed as a structured securities agreement by the SEC and, on November 24, 2008, forced the P2P lenders to package their loans as securities. You can read more about it all on the P2P Lending Expert’s website.
The reason why it’s important to look at this move in the U.S. is that it’s led to over 65% of American P2P lending being FSI2P – Financial Services Institutions to peer, not peer-to-peer.
The good news is that by being funded through institutions, loans are matched far faster. In the old days of peer funding, a loan could sit on a platform for weeks. Now most are completed in seconds, because the investors are programmed into the marketplace platforms to fund on demand. This has also created an issue for Lending Club and Prosper as the institutional investor funding is now dominating their markets to the near exclusion of retail investors.
An article in the Financial Times states the issue well:
“Lending Club has placed limits on the amount of loans investors can purchase and has also installed new technology that is intended to allow individual investors time to scan the site and give them a chance to compete for loans. The most sophisticated investors use computer programs to plug directly into the company’s platform and rapidly evaluate the best loans available. Late last year, Prosper installed speed limits to deter trading firms from buying up its loans unfairly by using multiple servers and rapid-fire computer software. Investors seeking to buy loans from Prosper are now limited to a maximum number of server hits per second and institutional investors are confined to buying ‘whole loans’ instead of the smaller pieces of loans intended for retail investors …
“Big investors may be seeking large amounts of loans in order to bundle them into securitised bonds which can then be evaluated by credit rating agencies and sold to even more investors. Last year, Eaglewood Capital, a New York-based investment firm, created the first P2P securitization, which was unrated. Securitizing P2P loans ‘will increase the complexity and interconnectedness with the broader financial market’, Iosco warned in its report.”
In an even more landmark move, the first P2P securitization to receive a credit rating occurred at the start of 2015, when BlackRock Financial Management created a P2P bundle called Consumer Credit Origination Loan Trust 2015-1. The deal was put together by packaging loans originated through Prosper worth $327 million. Moody’s gave the loans a rating of Baa3 for the first $281 million and Ba3 to the residual $46 million.
In fact, the securitization of the P2P lending industry in the U.S. creates this complex mix of marketplace platforms being majority funded by institutional investors who package their loans to pension funds and asset managers. That’s very different from the cuddly feeling of me lending to you that was the original intent when Zopa launched back in 2005.
But that has historically been the difference between U.S. FSI2P and U.K. P2P.
For most of the U.K. life of peer-to-peer lending, the lenders have been individuals. That has stifled the market a little bit, but as this marketplace blossoms the platforms adapt. Recently, the U.K. has seen a similar pattern to the U.S. As AltFl points out: Is P2P lending a thing of the past?
This is a very recent trend and may be because the sector has gained respectability after:
- Creating a trade association – The Peer-2-Peer Finance Association, P2PFA;
- Gaining a regulatory structure – Since April 1 2014, the Financial Conduct Authroity has supervised the P2P markets; and
- Being included in the formal markets of savings and loans – The Treasury now recognizes P2P as an investment vehicle for tax-exempt saving products called ISAs, while Metro Bank has partnered with Zopa for its savings products
All in all, what we’re really seeing is what was called Alternative Finance becoming the Risk Management Market for credit for financial institutions. The platforms take the risk and the banks fund them. It doesn’t remove the bank as an intermediary. It just means the bank gets more efficient profit for less cost. Or that’s how I see this developing.
Competitors are watching and waiting to copy what you do. Learn more about How to Avoid the Risks and Challenges in Creating Services for Products.
Chris Skinner is author of Digital Bank and Chair of the Financial Services Club