It's a fun club.

Photographer: Don Emmert/AFP/Getty Images.

Citigroup Joins the Lending Club

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Here's a fun press release about how Lending Club and Citi are teaming up to offer "affordable credit to underserved borrowers and communities." Like so:

All qualifying loans will be issued by WebBank, a Utah-chartered Industrial Bank, and purchased by Varadero Capital through a credit facility provided by Citibank.

Huh that is a lot of steps? Everyone gets something out of it:

Citi is expected to strengthen its Community Reinvestment Act score by assisting in the facilitation of loans to low- and moderate-income families, Lending Club would add more customers through a program that already has a guaranteed buyer, and Varadero plans to purchase loans that produce higher-than-average yields based on data-centric underwriting and low-cost servicing.

Isn't finance in 2015 cool? But isn't it a little odd that Citi will satisfy its Community Reinvestment Act requirements by lending money to a hedge fund so that that hedge fund can buy loans from a different bank, which will make those loans through an online platform? "It’s been very hard for Citi to meet their CRA requirements and because we lend online, this will help them make credit available to low- and moderate-income customers," says the chief executive officer of Lending Club, which is again odd: Citi, which has branches in communities, can't find people in those communities to lend to. But the Internet can. Arguably the Internet has replaced communities.

One story you could tell about "marketplace lenders" like Lending Club is that they are about disintermediating banks. Banks, classically, take money from savers and give it to borrowers. You could do that with a website: Borrowers go on the website and ask to borrow money, savers go on the website and offer to lend it, and they work out a deal without the costly and obscuring intermediation of a bank. This story seems to be wrong. Savers are pretty insistent about depositing their money with banks, and banks have to find somewhere to put it.

The other story you could tell is that marketplace lending is about disaggregating banks. Here are some things that banks do:

  1. They take in deposits from savers that can be used to fund loans.
  2. They find and evaluate borrowers to give the money to.
  3. They take the credit risk on those loans, losing money if the borrowers don't pay them back.

Much of the recent history of finance has been about separating things 1 and 2 from thing 3: Banks would take in deposits, make loans and then sell on the risk of those loans in securitizations. That has its pluses and minuses. For one thing, when the person making the loan isn't the person taking the credit risk of the loan, incentives can get, you know, bad; one popular story of the financial crisis is that it was caused by the separation between the people taking credit risk and the people making credit decisions.

But the Citi-Varadero-Lending Club deal separates all three things. Lending Club, with its website, finds borrowers, and with its algorithms, decides which of them are good risks. Varadero then picks the best borrowers and buys their loans, which presumably means that it takes the credit risk.  But it buys the loans "through a credit facility provided by Citibank," meaning, using money that comes from Citi's depositors. If you are depositing your money with Citigroup, some of it will be going to loans to low- and moderate-income families under this program. Just, you know, slowly. Like:

Doesn't the second way look less efficient than the first? None of those people in the middle work for free. Why would this make sense? 

I think there are two possible answers. One relates to a thing I like to say, including about Lending Club, which is that the purpose of banking is to conceal risk. This is why it seems unlikely that Lending Club could really disintermediate banks: People don't want to invest their savings by picking out individual borrowers to lend to. They want to chuck their savings in a bank and not worry about them; they want the bank to do its job of transforming risky loans into risk-free savings accounts. Adding more steps helps attenuate and obscure risk; each intermediary siphons off a bit of the risk that would otherwise be borne by Citi's depositors. Citi isn't lending money to low-income families; it's lending money to a rich hedge fund that's lending money to low-income families. The money goes to the same place, but at a further remove, so it's safer.

The other answer is a division-of-labor story, in which Lending Club is better at sourcing loans and algorithmically evaluating them, and Varadero is better at choosing which loans to invest in, than Citi is. So it's worth it for Citi to incur the frictional costs of outsourcing that work. You can be skeptical of parts of that story -- Dan Davies has his doubts about the theory that big-data-driven startups are smarter than banks at loan underwriting -- but there's a lot to be said for it. The Internet might well be a better place than a Citi branch to find borrowers, particularly lower-income borrowers in neighborhoods that are not full of Citi branches. And Varadero might well have better incentives to choose good loans than a Citi lending officer would.

In this model, Citi has one job, but it's an important one: It has deposits that can be used to fund loans. Disaggregation may devalue banks' ability to match borrowers and lenders, or to evaluate loans, or to manage credit risks. You could even tell a story in which Lending Club and Varadero and whoever are better at evaluating and managing risks because they can't rely on subsidized deposits of other people's money. But Citi still has a role to play even in Lending Club lending: That lending requires money, and Citi is a bank, and banks are -- still -- where the money is.

  1. I'm old enough to remember when they were called "peer-to-peer lenders," but no one thinks that Lending Club lenders are, like, human members of a club any more. 

  2. Or at least the first-loss risk. The press release is a little sparse on details, but presumably if all $150 million of loans defaulted and went to zero, Citi, as well as Varadero, would be sad.

  3. I mean, not that much. Citi has like $900 billion of deposits -- and $1.8 trillion of total assets -- so we're talking way, way less than a tenth of 1 percent of your money going to this program.

  4. I mean I exaggerate, Citi is on the Internet. I don't really know why Lending Club would have a categorical advantage over Citi at, like, making web pages. Though also I kind of believe it?

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net