02 Jul Marketplace lending: the next revolution?
In 2012, Patrick Molineux, in his book Connected Consumer and the Future of Financial Services* suggested that the banking and insurance industries might prove “too complex to construct as P2P commodities”. “The question for P2P lending”, Molineux suggested, “is whether there is a sufficiently deep well of consumer trust to transform the market. That trust is rooted in the ability of other consumers to pay and the longevity of the P2P platform”. At that time, Molineux felt that if both of these criteria were satisfactorily met, the credit industry could be changed forever by peer-to-peer lending.
Molineux went on to suggest that, for this alternative form of lending to really change the face of the credit industry, it must “engage the wealthy in placing significant sums on loan as part of mainstream wealth management portfolios, and grow the size of loans expanding into P2P mortgages”. A question remained over whether the nascent industry could enter the mainstream and really offer competition to banks. Writing a year later in a guest article for Forbes magazine, Molineux acknowledges that, not only was peer-to-peer lending “on the rise”, but that a form of peer-to-peer insurance had even become reality.
Indeed, this is a good indicator of the rapid growth of peer-to-peer lending: in the last two years alone, it has grown from a position of potential disruptor to significant threat. The global growth rates illustrate both the huge public appetite for an alternative form of finance and the potential for this industry if these growth rates continue. Marketplace mortgages are now a reality, with a number of buy-to-let mortgage providers operating in the marketplace space, and many other variations on the model have emerged in the interim period (see the case studies section of this report for details). In fact, the dominance of institutional capital on US platforms, in particular, has begun to cause concern among some early supporters of the industry.
Growth
Marketplace lending is growing exponentially. US platform Lending Club’s recent IPO marketing material welcomed backers and the uninitiated alike to the “We’re Just Getting Started Club” – and this kind of bold statement of intent does not seem incongruous given the industry’s enormous success thus far. From inception in 2007, it took Lending Club until Q4 2012 to reach its first billion in loan originations. By the end of 2013, originations stood at three billion, and, as of Q3 2014, they stood at six billion. Its main rival in the US market, Prosper, passed the one billion mark in April 2014, and six months later had originated another billion to end Q3 with two billion in cumulative originations. London-based brokerage Liberum estimates global compound annual growth rates of 136 percent between 2009 and 2014(E) and these rates are even higher in the key markets where marketplace lending has taken strongest hold. In the UK market, the fastest growing segment, business lending is growing at a rate of well over 200 percent year-on- year. Well established platforms are frequently doubling their loan volumes annually, while new entrants constantly appear to provide diversity and competition in the market.
Revolution or evolution?
Marketplace lending is often described as a revolutionary innovation, and it is certainly true that the model appeals to entrepreneurs and the technologically savvy, in particular. However, it might be said that marketplace lending is in fact evolutionary, rather than revolutionary – it is doing essentially what banks were established to do – but using the tools and methods that have become part of everyday life in developed economies worldwide over the last two decades. It is no secret (or surprise) that these platforms have been established by innovators – entrepreneurial thinkers certainly – but also former employees of the very banks and financial services agencies these new platforms are attempting to displace. In fact, Charles Moldow, CEO of Foundation Capital, one of the key investors in Lending Club, explains that “marketplace lending is not a radical concept – it’s a more efficient one”.* At its core, marketplace lending is a simple concept – whereby the savings from greater levels of efficiency are used to fund better interest rates for borrowers and investors, while these efficiencies allow for healthy profit margins for the platforms themselves. On this point, very few of the top platforms are actually posting a profit, focusing on growing the business to achieve scale, but this is something that is likely to change as more borrowers and investors adopt the marketplace model.
Key competitive advantage
The key competitive advantage that these companies have is their efficiency – while banks spend up to 30 percent of their operating costs on resource-draining branch networks, marketplace lending platforms operate fully online. The major platforms all carry out some degree of in-house underwriting and risk assessment, but the very nature of this online model means that they can use a much wider array of data than the incumbents generally do. Meanwhile, debt collection procedures vary from platform to platform – with some outsourcing part or all of this to external agencies.
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