Peer-to-peer lending, the online platforms which allow you and I to lend directly to people and businesses who want to borrow, has been hailed as disruptive technology. Cheered by savers who have been stuck with rock-bottom interest rates, and by those who have sought finance from reluctant banks, the industry has grown exponentially since its birth in 2005. It has been seen as one in the eye for a financial sector at the heart of a crisis which has punished us all; which is why it might be off-putting to now see Goldman Sachs lurking with intent.
By bringing together savers and borrowers directly, peer-to-peer lending, or P2P for short, bypasses the banks. The cumulative total of loans is forecast to reach £2.5 billion in the UK this year, according to the trade body, Peer2Peer Finance Association. Although these totals are as yet still a tiny proportion of the UK’s £170 billion consumer credit market, this could change fast.
Its credentials as a game-changing industry prompted the Bank of England’s Andrew Haldane to suggest: “The banking middle men may in time become the surplus links in the chain.” However, following news that the giant investment bank Goldman Sachs may be poised to back peer-to-peer lender, Aztec Money, it is clear that the very nature of P2P lending is changing. Banks and other big institutions are quietly recasting themselves as new links in the chain.
Can’t beat em? Join em
Banks are themselves becoming major lenders on some P2P platforms. For example, Forbes estimates that in the US, 80-90% of the capital lent through the two largest P2P lenders, Prosper and LendingClub, is now institutional money.
This means that when you take out a P2P loan, you are now less likely to be borrowing from individuals who often combine a social approach to lending with their desire for investment returns. As an investor, you might find it harder to compete for the best value loans.
Some banks and big institutions are buying up bundles of loans originated on P2P platforms, in some cases repackaging them and selling them on as asset-backed securities. Those with all but the sketchiest memories will immediately recall the way US mortgages were repackaged and traded prior to the 2007 global financial crisis.
Showing some maturity
So, instead of P2P displacing the banks as lenders, it seems they are becoming a way for banks to outsource their lending process. There are some clear reasons why this may make good business sense for the banks.
Traditional banking is based on a risky and these days expensive concept of “maturity transformation”. So savers deposit money with banks in the expectation that they can withdraw it at short notice while the bank lends the money on a medium to long-term basis to firms to fund their day-to-day business or new investment.
To achieve this balancing act, banks have to hold enough money in reserve to meet the demands of savers who want their money back. Reserves must be very safe, accessible investments which therefore offer low returns. This makes the overheads of maturity transformation expensive.
It is also important that savers are confident they can get their money back on demand to stop everyone withdrawing their money en masse (a run on the bank, as seen at Northern Rock in 2007). Confidence is underpinned by deposit protection schemes – for example, in the UK, savers can get back up to £85,000 of deposits from the industry-funded Financial Services Compensation Scheme.
P2P does not have these overheads. P2P investors cannot necessarily get their money back on demand and are not protected by any centralised compensation (though some P2P platforms have their own small-scale schemes).
Traditional banks also have a legacy of aged IT systems. By contrast, exploiting technological innovation to assess credit risk rapidly and accurately is at the heart of P2P.
When you ask a bank for a loan, it will gather information to generate a credit score – a statistical indicator of the probability that you will default – and check you out with a credit reference agency.
P2P lenders also use these techniques but are increasingly absorbing other data into their risk profiling as well. This includes so-called “big data” – for example, the way you use your mobile phone and social media sites. By lending through P2P platforms, banks can tap into these innovations without themselves having to invest in new IT.
Rather than displacing banks, it looks as if P2P may be enabling banks to shift from their expensive traditions to a more efficient IT-savvy business model, but in the process they will also shift more risk onto consumers.