Peer-to-peer lending, the online platforms that allow us and you to loan directly to individuals and companies who wish to take out loans, has been hailed as a disruptive technology. The adoration of savers who are stuck with the lowest interest rates as well as those who have been looking for loans from banks that are reluctant. The industry has seen exponential growth since its inception around 2005. It’s been described as a sign of weakness for a financial sector that is at the center of a financial crisis that has afflicted everyone in the world. That’s the reason it is a bit off-putting to find Goldman Sachs lurking with intent.
By bringing together savers as well as lenders directly, peer-to-peer lending, or P2P in short, bypasses banks. The total amount of loans is expected to hit PS2.5 billion within the UK in the coming calendar year in accordance with the trading association Peer2Peer Finance Association. While these figures are still just a tiny fraction of the United Kingdom’s PS170 billion market for consumer credit, the situation is likely to change quickly.
Its potential as a game-changing sector has prompted the Governor of the Bank of England, Andrew Haldane, to say: “The banking middlemen may in time become the surplus links in the chain.” However, after news that the massive financial institution Goldman Sachs may be set to support a peer-to-peer lender, Aztec Money, it is obvious that the nature of lending through P2P is evolving. The banks and other major institutions are slowly transforming themselves into new chains of links.
Can’t beat them? Join em
Banks themselves are now major lenders on a few P2P platforms. For instance, Forbes estimates that in the US, around 80-90% of capital lent to the two biggest P2P lending platforms, Prosper and LendingClub, is now institution-owned money.
That means that if you apply for loans through P2P, this means that you are less likely to borrow from people who typically mix a social inclination to lending along with their need for returns from investments. If you are an investor, then you may be unable to compete for the most value-for-money loans.
A few banks and large institutions are acquiring packages of loans made via P2P platforms and, in some instances, repackaging them before selling them as asset-backed securities. Anyone with even the tiniest of memories will recall how US mortgages had to be packaged as well as sold in the years prior to worldwide financial crises.
Looking a bit mature
Therefore, instead of P2P replacing banking institutions as a lender, it appears that they are now a method banks can outsource their lending processes. There are a few clear reasons that this could be an excellent business sense for banks.
Traditional banking is founded on a risky and, nowadays, expensive notion called “maturity transformation.” Thus, savers deposit funds with banks with the hope that they’ll be able to withdraw the money in a short time, while banks lend the funds on a temporary to long-term basis to finance their day-to-day operations or to fund new investments.
In order to achieve this balance, banks must keep sufficient reserves to meet the needs of those who wish to get their money returned. Funds should be extremely secure, easily accessible investments that provide low returns. This makes the cost of transforming maturity into cash expensive.
It is equally important that savers feel confident they will get their money back upon demand so that they can stop withdrawing money in masse (a bank route, as seen at Northern Rock in 2007). It is supported by deposit protection programs – such as, in the UK, savers can recover the equivalent of PS85,000 of their deposits through an industries-sponsored Financial Services Compensation Scheme.
P2P doesn’t have the overheads of traditional platforms. P2P users aren’t guaranteed their funds back at any time and are not covered by centralized compensation (though certain P2P platforms offer their schemes of a smaller scale).
Traditional banks also have a long-standing legacy of outdated technology. However, leveraging technology to evaluate credit risk quickly and accurately is the underlying principle of P2P.
When you apply to the bank to lend you money, it will collect information to create the credit score – an indicator of the statistical possibility of default and then verify your credit score through a credit reference agency.
P2P lenders use these strategies but are increasingly adding other information to their risk profiling, too. This is referred to as “big data” – for instance, how you make use of your mobile phone or social media websites. Through lending via the P2P platform, financial institutions are able to benefit from these technologies without investing in the latest technology.
Instead of replacing banks, it appears that P2P could be helping banks to move away from their old, expensive ways of doing business towards a more efficient and technologically-savvy business model; as a result, they’ll be transferring more risk onto the consumers.