Finance

Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

A chill wind is blowing through the peer-to-peer lending industry in the wake of the abrupt departure of LendingClub's CEO and several managers.

Details of what prompted their exit are still murky. But the company's disclosure of sale abuses and potential conflicts of interest show even the biggest and most transparent platforms can slip up.

With regulators now stepping in to untangle the mess, these upstarts who use the internet to match borrowers with people willing to finance them may start to look a lot more like regular lenders. And that may only help traditional banks.

Lending Clubbed
The departure of LendingClub's CEO and several loan managers has hit the company's stock price
Source: Bloomberg data

Peer-to-peer platforms have already been co-opted to a large extent by the financial industry, with banks investing in them directly, striking partnerships, and buying up loans and packaging them up for investors.

Banks and investment firms funded 32 percent of the $1.3 billion of peer-to-peer loans issued in the U.K. last year, according to a report by Cambridge University and Nesta, with the figure closer to 55 percent at LendingClub in the first quarter.

Britain's biggest banks are all expected to have their own marketplace platforms in the next three years, according to a KPMG survey last year. JPMorgan is collaborating with LendingClub rival On Deck for small-business lending, while Wells Fargo is also opening its own a fast-track small-business loan platform. Peer-to-peer is already starting to look a lot like peer-to-bank.

Old Bankers' Club
LendingClub loan origination mix by funding source in Q1 2016
Source: Company data

That relationship is unlikely to break apart (even if Jefferies and Goldman Sachs are holding off, at least temporarily, snapping up LendingClub loans).

Faced with the prospect of a wider industry crackdown, peer-to-peer platforms will have to take some old-fashioned medicine and look even more like the industry they were designed to disrupt.

If regulators decide peer-to-peer lenders need to bolster capital or their compliance procedures, what makes these loan match-makers so different from banks -- a nimble, automated cost base and freedom from regulators' most onerous capital requirements -- may fade over time. And that may make them more palatable partners for banks in the long run, even if it hurts their runaway growth rates.

The risks of using and investing in an automated online finance platform have been clear for a while, even before LendingClub's woes. These platforms lack "skin in the game" in that, because they don't bear the risk that the borrower may default, they may make poor lending decisions, according to Cormac Leech, a fintech analyst at Liberum.

Earlier this year, Moody's warned of a faster-than-expected build-up of delinquencies on securitized U.S. peer-to-peer debt. And Chinese authorities' arrest of executives at online platform Ezubo over an alleged $7.6 billion fraud makes LendingClub's issues look like a picnic.

Regulators aren't sitting still: They have issued guidelines and rules to protect consumers and set minimum standard for governance and risk management.

But LendingClub's disclosure suggests some platforms still might be too nimble for their own good. The company has grown staff at a pretty rapid pace, swelling from 976 employees and contractors to 1,545 in the space of one year. Rival OnDeck has more than 600 employees, while Zopa has 175 staff in London. Are these numbers big enough to keep operational risk under control? That's a question regulators will want to know the answer to. More staff and, potentially, capital may be the outcome.

A Growing Marketplace
Total global peer-to-peer loan issuance is expected to swell to $290 bln by 2020
Source: Morgan Stanley estimates

Right now, this is not a systemic financial issue. Total peer-to-peer lending in the U.S. in 2014 was about the size of a quarter's profit at JPMorgan. But this is a market that could eventually hit $290 billion worldwide by 2020, according to Morgan Stanley.

The combination of a turning credit cycle, an investor re-pricing of risk and more regulatory scrutiny make it likely that change is on the way -- and that the cultural and regulatory gap between fintech and traditional banks will narrow. And so, too, will the upstarts' competitive advantage over the incumbent.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lionel Laurent in London at llaurent2@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net