When the peer-to-peer loan service LendingClub arrived 2007, many envisioned a major disruption to end the bank loan business as we knew it. What next: Lending money on Facebook? (Talk about an excuse for consumers to press the “like” button.)
Amidst the speculation, some industry leaders put their ear to the ground and heard the low rumble of tech-savvy, nimble, flexible lenders preparing to outflank banks—much of it drummed up by LendingClub’s French CEO-founder Renaud Laplanche, a charmer who boldly predicted that directly connecting borrowers with lenders would lead to the demise of traditional bank loans.
And as the financial crisis wore on, such vibrations only intensified. Added regulations made established institutions more complicated and sludgy—while LendingClub wannabees with different business models and slick, tech-savvy interfaces cascaded into the market.
Yet despite predictions that peer-to-peer would run roughshod over traditional banks, the forecast 10 years on isn’t nearly so drastic. Facebook did get into payments via its Messenger service in 2016, but continues to refute any suggestion it will enter the loan market. Meanwhile, it’s clear banks now see opportunities as they look at peer-to-peer players. But what do these opportunities look like, and how can banks take part?
Peer-to-peer in 2017: Sizing up the market
Since LendingClub bowed, peer-to-peer has evolved into marketplace or alternative lending. More institutional investors, and even banks themselves, increasingly finance today’s loans. Thus compared to 2007, LendingClub can now create a market for retail investors to purchase notes, while balance-sheet lenders such as SoFi, OnDeck and Kabbage/Karrot can keep loans on their balance sheets until they find investors.
The common thread: The alternative lenders, many based in Silicon Valley or Silicon Alley, are tech-driven and agile—and often promise lightning-quick approvals delivered via smooth user interfaces.
The alternative share of the lending market is not huge, compared to traditional lending market, though it has grown quickly. And, alternative presents “a tremendous opportunity,” say Rohit Kumar and Rashmi Singh of Ernst & Young. The two were among the co-authors of a recent paper, “Alternative Lending.”
For example, the entire mortgage market in the U.S. is worth upwards of $1 trillion, the report says, while alternative lenders have an $800 million share. Of the consumer lending market of $450 billion, $15.4 billion belongs to alternative lenders, the report says.
The marketplace lenders operate in many spheres, such as:
- Mortgage lending (Quicken Loans as well as Lending Home, Realty Mogul)
- Consumer loans (LendingClub, Prosper, Avant)
- Student loans (SoFi and Common Bond)
- Small and medium enterprises (OnDeck and American Express)
Marketplace and traditional lenders can partner at various points in the lending cycle. A marketplace lender might, for example, originate loans for a bank, or make a technology partnership with a bank for underwriting—since the alternative lenders generally claim their underwriting is faster and has less friction. Banks and more traditional lenders are able to securitize and fund loans for alternative lenders.
Strategic partnerships are a fast-growing segment: J.P. Morgan Chase has partnered with marketplace lender OnDeck, and Chase and Intuit drive more than 80 percent of referrals for OnDeck, according to the Ernst & Young report.
This graphic from a recent Deloitte report titled “Marketplace Lenders and Banks: An Inevitable Convergence?” gives insight into the various possibilities:
Source: Deloitte Consulting report “Marketplace Lenders and Banks: An Inevitable Convergence?”
Tiffany Johnston, who currently leads Deloitte Consulting’s Lending Center of Practice (which focuses on lending innovation and excellence in lending), cited three areas where marketplace lenders are doing really well—and that the banks have to figure out:
- The first: the marketplace lenders’ smooth digital experience and agility: “How do you own that customer?” Johnston asks. “How do you create an experience and a value proposition with your products and solutions that really means your customer wants to deal with you?”
- The second: the potential for bank platforms that match borrowers with funders. “That’s where there are a lot of opportunities for banks to partner with existing entities,” she says. “Our projection is that some of the marketplace lenders with good platforms will fail, and banks might buy them.” To do that, however, she pointed out that failure-averse banks will need to be comfortable thinking like startups, to “fail small and fail fast.”
- The third: data. Marketplace lenders use expanded data on trends and so forth, which the banks have but seldom “actually activate it for the benefit of their clients, or their customers.” Or if they do, it’s not as well as the marketplace competition.
Kumar and Singh also note that marketplace lenders give banks access to additional customers, often in segments banks cannot serve profitably or have trouble serving, such as the underbanked, including students or people with subprime credit.
Cautions: from culture to controls
But there are cautionary notes as well. Kumar and Singh point out that bank regulation is very different from the regulation of marketplace lenders. In any relationship, both parties need to take that into account. What’s more, technology platforms and cultures may not mix well.
Also, they pointed out, the underwriting strategies are very different. The banks often use proprietary credit-scoring technology to underwrite loans, while FinTechs such as SoFi employ an “ability to repay” assessment of a borrower. It specifically excludes a FICO score in favor of factors such as a borrower’s current cash flow and future earnings potential.
Regulation is also a big issue that makes banks cautious, says Leo Loomie, vice president at Digital Risk.
“There's a lot of regulatory uncertainty in the market as a whole right now,” Loomie says, pointing to the future of Dodd-Frank financial regulations. “Most folks don't actually have a very good feeling for how regulated they will or won’t be 12 months from now. So no one wants to make big bets when they don't know what level of control they'll have to put in place.”
Nor do the big banks have any idea how marketplace lenders would survive a down cycle. LendingClub and OnDeck both reported dismal fourth quarter results recently, sending a chill through the industry.
“The question is whether these lenders have the discipline to stay the course and not make bad lending decisions,” Johnson notes. “The suspicion is that when there is another downturn—which there will be, because there always is—that some of these guys are going to have such losses that they don’t survive.”
And so that perceived initial threat posed by LendingClub’s arrival has come somewhat full circle in 2017. Following that bad fourth quarter, LendingClub revealed that some loans had not met investors’ criteria, resulting in Laplanche’s resignation in May. The company’s stock is down 77 percent since it went public in 2014, sitting somewhere around $5 per share.
Lesson learned? Going forward, perhaps peer-to-peer lenders will need banks and their cautious attention to detail a lot more than they’d like to think.
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Jeanne Pinder is the founder of ClearHealthCosts.com, an award-winning startup bringing transparency to the health care marketplace. She was an editor, reporter and human resources executive at The New York Times for close to 25 years, and has also worked at the Des Moines Register, Associated Press and Grinnell Herald-Register.