Peer-to-peer lending: the only way is up

A decade on from the peer-to-peer (P2P) lending business model being pioneered in both the US and the UK, the P2P model might not yet be providing major competition to the banking sector but the concept has spread to many other countries.

In its recently-published report, ‘Global Peer-to-peer Lending Market 2016-2020’, Dublin-based Research And Markets, which describes itself as “the world’s largest market research store” forecasts that the P2P lending market worldwide will enjoy a compound annual growth rate (CAGR) of 53.06% over the period 2016 to 20120.

Indeed, in the wake of Brexit, that projected figure may prove overly conservative. The impact of the UK’s decision to exit the European Union has created fresh uncertainty on global economic growth prospects and probably extended the era of low, zero and negative interest rates. The Bank of England (BoE) has already cut its base rate – already at a record low of 0.5% since 2009 – even further this month, to 0.25%. With investors having to look further afield for decent returns and ready to accept a greater degree of risk in return. The shrinking branch networks of many European banks provides a further spur to online lenders.

The P2P sector’s attraction to investors increased significantly in the wake of the 2008 global financial crisis, when central banks around the world responded with sharp reductions to interest rates and much lower returns on conventional savings accounts. With the US currently the only major world economy where rate hikes are a likely prospect in the near term – and even then likely to prove only modest – this attraction is steadily increased.

Many P2P platforms focus on property lending and consumer loans rather than lending to business; indeed research and analysis firm Business Insider predicts UK P2P lending will grow at a 45% five-year compound annual rate to reach £16bn (US $21bn) by 2020 and expects property lending to represent the largest share of P2P activity by the end of this period.

Most recently, P2P lending has started to become established in China, where investors are similarly frustrated by low interest rates and have turned to the country’s underground or shadow banking system for better returns. While still a fledgling sector in comparison to the US, over the past two years the number of Chinese P2P companies has increased from 880 to around 2,600.

A report by the Association of Chartered Certified Accountants (ACCA) suggests that the volume of P2P lending in China had reached anywhere between US20bn to US$40bn by the end of 2015. Growth has been sufficiently swift for the Chinese Banking Regulatory Commission (CBRC) to last year issue proposals for regulating the P2P industry to reduce risk. China’s government introduced its first major internet finance ‘guidance’ policy in July 2015, which imposed measures such as minimum registered capital requirements for online P2P platforms.

Drivers for growth

The post global financial crisis era and the impact of the Basel III capital adequacy regime on the banking sector – and the appetite of its members for lending to smaller businesses – has been a key driver for the P2P market’s growth.

P2P enables individuals and businesses to both lend money and have easy access to funding via an online platform, thereby eliminating the banks and reducing the costs of intermediation. Investors can gain a higher rate of interest and borrowers gain funding at a lower rate than those available from many other sources. P2P industry pioneers such as Funding Circle, active on both sides of the Atlantic, have developed their platforms using extensive data sets and algorithms to assess the creditworthiness of borrowers using a range of variables like credit scores, financial history and social media usage. Over the years, the business model has evolved and a growing number of institutional investors have used P2P platforms to develop a loan portfolio.

According to Research And Markets, a steady increase in loans to small and medium enterprises (SMEs) will be a main driver for the P2P market’s growth. “We expect more P2P lending and crowd funding with government support, which would help investors to make small investments in private companies,” the firm notes.

“The European Commission (EC) is evaluating soft-law measures that could help promote P2P lending and crowdfunding across Europe. The Commission is investigating how government funding could be aligned to support P2P lending and crowdfunding platforms and investment opportunities during the forecast period.”

However, one of the potential clouds seen on the horizon by the firm is increasing regulatory risk. “If we look at the present market, the P2P lending platforms are subject to regulations that are for certain consumer banking and other financial institutions,” the firm comments.

“The consumer credit that is provided by the banking and financial institutions are subjected to a number of laws (which) regulate the credit life-cycle that includes underwriting, payment terms, agreements and disclosures, advertisements and solicitations, and debt collection practices.

“There are also other laws like privacy and data security and anti-money laundering laws (AML) that regulate the relationship between the customers or borrowers and the banking and financial institutions.”

Greater regulatory scrutiny can also be expected in countries where P2P platforms are still in the early stages of development such as India, which has no more than around 30 companies. Nonetheless, the Reserve Bank of India (RBI) is already deliberating on how the sector should be regulated; publishing a discussion paper with proposals for regulating P2P lenders last April. P2P could extend financial inclusion in a country where groups such as SMEs and small farmers have often found it difficult to access loans from the banks.

The P2P sector has also attracted some negative headlines in recent months, such as the resignation in May of the founder and chief executive officer (CEO) of San Francisco-based Lending Club, which had moved its focus from P2P lending to consumer loans. Renaud Laplanche lost the confidence of the board following allegations of a lapse in its business practices.

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