Making Banking More Democratic, or Riskier?
Need a few thousand dollars to pay down credit card debt, fund an elective medical procedure or put on a new roof? How about hundreds of thousands of dollars to buy equipment for your small business or buy a home? Peer-to-peer lenders want you. In the past few years, companies like Lending Club, Prosper, Zopa and Funding Circle have created online platforms that allow total strangers to lend one another money over the Internet. To the industry’s backers, peer-to-peer lending, also known as marketplace lending, is about democratizing finance, a way to make borrowing money more efficient. To its detractors, it’s an end run around bank regulation with a good chance of blowing up. So far, the industry has seen both enough rapid growth and financial turmoil to make either path plausible.
Lending Club, the first peer-to-peer lender to go public, roiled markets in May when it asked its founder and CEO to step down for failing to disclose an investment and announced that it had sold misdated loans. The moves came after a rough stretch, as turbulence in capital markets prompted investors to pull back from buying Internet loans. At the same time, the U.S. Treasury Department released a report calling for increased disclosure and oversight for peer-to-peer lenders. Online alternative finance companies -- including crowdfunding sites and peer-to-peer lenders -- generated more than $36 billion in financing last year, according to a KPMG report. High-net-worth individuals, hedge funds and banks have been piling in, and companies like BlackRock are even bundling the loans and creating tradable securities. In the U.K., holders of tax-free savings accounts known as ISAs are now able to invest in peer-to-peer loans. Morgan Stanley counts more than 1,500 peer-to-peer lenders in China; the bank estimated their total loan volume in 2015 at $33.2 billion, more than in the U.S. One of them, however, was a $7.6 billion Ponzi scheme.
It may seem quaint in an era of too-big-to-fail financial institutions, but banks historically took in deposits from the community and lent that money back to the community. Playing middleman earned banks a nice spread. Peer-to-peer lenders sought to revive the tradition by linking online communities of borrowers and savers. Zopa started out in the U.K. in 2005, the same year that Prosper formed in the U.S. Lending Club was founded a year later. As its CEO Renaud Laplanche tells it, the opportunity was clear: Banks were charging borrowers much higher rates than they paid savers and an online loan market could be more efficient. But hurdles soon arose: In 2008, the U.S. Securities and Exchange Commission objected, saying the companies were selling unregistered securities. Both Lending Club and Prosper shut down temporarily while they worked with the SEC to develop an oversight plan. Most peer-to-peer lenders are pure middlemen, connecting borrowers with investors online, and making money by charging origination and servicing fees. Loans as small as $1,000 can be funded in increments of as little as $25, although the original vision of tapping many small lenders has given way to a reality in which much of the money is coming from hedge funds, institutional investors and the wealthy. Peer-to-peer lenders see their advantages as lower costs and better risk management — they say their credit assessments, based on algorithms that look at many factors, are more sophisticated than traditional credit ratings. That was called into question after LendingClub disclosed that it had underestimated the risk on some loans.
Proponents say efficiencies like those will let peer-to-peer lenders remake banking, with some predicting $1 trillion in loans originated through online marketplaces globally by 2025. Some traditional bankers say competition for borrowers could cause underwriting standards to plunge, threatening the financial system. Peer-to-peer lenders aren’t regulated like banks, and usually don’t hang on to any portion of the loans. That’s drawn comparisons to the originate-to-distribute mortgage model, which fueled the U.S. housing bubble. In the U.K, a former top regulator has predicted a P2P meltdown that will make regular banks look like "lending geniuses."
The Reference Shelf
- Peter Renton, a longtime blogger focusing on peer-to-peer lending, offers a set of explainers and resources for lenders and borrowers at his Lend Academy site.
- Charles Moldow, an early investor in Lending Club, makes the case for why marketplace lending will outcompete banks.
- This Bloomberg Markets story explores the industry’s roots and this one its surging popularity.
- A QuickTake on shadow banking.
First published June 2, 2015
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Noah Buhayar in Seattle at email@example.com
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