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Peer to Peer Lending and Its Role in FinTech

What Is It?

“Peer to Peer Lending” (also known as “P2P Lending”), “Marketplace Lending”, “Crowdsourcing” or the “Grey Market” (what they call it in China)) is a fast growing and evolving industry.  Morgan Stanley research estimates that P2P lending companies could originate up to $480 billion in loans by 2020.  Peer to Peer lending has also become a major player in the financial technology field, also known as FinTech.  If these terms are new to you, peer to peer lending refers to companies that match lenders and borrowers without the use of the traditional banking systems.  They are intermediaries that are usually online investment platforms that offer identity verification, proprietary credit models, loan approval, loan servicing and legal and compliance.  This can be an attractive alternative for a borrower as loans can be applied for online, anonymously, and in a timely fashion.  The whole process can be as quick as a few days with the proper information.  It can also be attractive from a lender’s perspective because, by cutting out the middle man or the bank, service and overhead fees are reduced which, in turn, improves the economics of the loan.

In the US today there is a robust list of companies that lend to individuals and businesses in P2P fashion (SoFi, LendingTree, Prosper, Lending Club and Upstart to name a few).  When using these sites, you will see loans for things such as debt consolidation, small business, student loans, bad debt, mortgage, green loans and major expenses.  Most sites offer APR’s in the range of 5-35%, loan terms of around 1-5 years and maximum loan amounts ranging from $30,000-$100,000.  This may not be the first place small businesses and individuals think to look for borrowing, but it is probably the most seamless process to apply and borrow.  And in many cases, this may be the only option for borrowers with poor credit.  That being said, those with poor credit or a lack of established credit are going to pay a higher rate.

Security & Risk

Investing or lending on a peer to peer site begs the question of security and risk.  Although these businesses are regulated by the SEC and do offer transparency, that doesn’t mean P2P lending comes without risk.  Most of the industry has yet to go through a full economic cycle and it remains to be seen how these companies hold up with significant stress on the consumer.  The bulk of the growth in this industry came years after the 2008 financial crisis.  It wasn’t until regulators came down hard on banks that the opportunity really flourished.  Since that time, traditional fixed income rates have hovered around historic lows, causing investors to search for yield.  P2P lending is another example of risk-taking in this low interest rate environment.  What’s important to remember when lending on these sites is that these are unsecured loans and the possibility of loss of capital is real.  There is no standardized process or history of loan origination on these sites.  These companies have their own black box credit model based on a number of different factors (most notably FICO scores).  It remains to be seen how well these proprietary models hold up in times of distress and increased defaults.

Institution Involvement

Another interesting dynamic is the migration of larger institutions into the P2P lending and FinTech space.  The University of Cambridge and Nesta found banks and institutions accounted for a quarter of P2P lending in 2016.  Many of these loans are being packaged and sold to larger institutions.  This is another example of risk taking, this time at the institutional level.  Banks are also realizing the opportunity that exists and are partnering/buying P2P technology companies (ex.: JPMorgan and OnDeck).  It goes without saying that this is a quickly evolving space and one that is important to keep an eye on with future competition, regulation and market cycles.