Peer-to-peer (P2P) lending has come a long way in a short space of time. Originally formed as a platform enabling individual investors to plug the funding gap for small and medium-sized enterprises (SMEs), after the financial crisis of 2008 in exchange for a healthy return, it is now attracting the big guns of global finance.
P2P lenders see themselves as providing an essential service to restart ailing economies, but also have a grander vision to revolutionize credit by disintermediating banks from the traditional lending process.
Using new technology, they have been able to make loans at lower rates for borrowers than traditional bank loans while offering higher returns for investors.
A variety of providers have entered the market in the UK and the US, which is where P2P lending, also known as crowdfunding, is most common. So far, the rise of P2P lenders has not threatened the business models of big banks, which regards the industry as providing a service they no longer wish to pursue – the provision of small, unprofitable loans to SMEs.
The massive deleveraging by Europe’s banks, which have cut more than $3 trillion in assets, has sparked a secular shift as banks pull back from lending, forcing companies to look at alternative forms of financing, such as the capital markets.
This shift plays to the business models of investment banks, but recent developments in the P2P space have raised its profile, and its potential to disrupt the banking industry.
Firstly, the size of the sector is growing. A report by Ernst & Young says the three biggest P2P lenders in the UK have now lent more than £600 million, while a recent survey by Nesta predicts the industry will end up being worth £12 billion a year in the UK.
Lending Club, one of the leading P2P lending platforms in the US, boasts former US Treasury secretary Lawrence Summers and ex-Morgan Stanley CEO John Mack as directors and expects to lend around $1.5 billion this year.
In the UK last month, the Funding Circle, the UK’s leading P2P platform – which has lent more than $250 million since its inception in 2010 – joined forces with San Francisco-based business lender Endurance Lending Network in a deal aimed at tapping into what it sees as the $100 billion funding shortfall for small businesses in the US economy.
Speaking at the deal’s announcement, Samir Desai, co-founder and chief executive of Funding Circle, says: “Financial services is going through the most significant disruption for a generation. The way businesses borrow is being transformed by eliminating the obstacles of an outdated banking system and putting owners directly in touch with investors looking to earn attractive returns.”
There are other signs the industry is coming of age. This month, Eaglewood Capital, a New York-based investment firm, bundled together $53 million-worth of P2P loans into a securitized structure similar to the vehicles that sparked the US sub-prime crisis.
Liam Collins, co-author of a report on P2P lending by Nesta, says: “It’s clear that the P2P model is moving more towards an institutional client base and the platform was created to provide a completely new product – the provision of SME loans – to institutional investors.”
While no one doubts the P2P model is innovative, the question is whether it is big enough or robust enough to become a long-term viable alternative to traditional bank finance.
In the US, only accredited investors – defined as having a net worth of more than $1 million – can participate.
James Meekings, co-founder of the Funding Circle, says: “There are currently nine million accredited investors in the US, which is a huge market, as they collectively manage trillions of dollars of net worth. To build a really successful business that gets finance to small businesses quickly and efficiently we will continue to focus on accredited investors.
“However, looking ahead five to 10 years, we would love to offer this investment product to anyone in the US.”
Meanwhile, the industry as a whole is fragmented and lacks a common regulatory oversight.
Edwin Herrie, head of financial institutions for KPMG in the Netherlands, says: “Crowdfunding is a very interesting initiative but it lacks the investment or credit analysis to protect individuals when something goes wrong.”
With institutional investors entering the market and applying their own internal risk model to add an extra layer of robustness, P2P lending is gaining in importance.
Herrie believes its future lies in cooperation, not competition, with traditional lenders and has already had approaches from leading Dutch banks looking to participate with the new breed of P2P lenders.
“Crowdfunding has been around for hundreds of years in the form of traditional banks – they take money from individuals and transform it into corporate loans,” he says. “One solution is for regular banks to get together with crowdfunding platforms to act as funding agents.”
As the line between traditional finance and P2P lending becomes blurred, banks will feel less threatened and will start to shape the future of this fledgling industry.