tag:theconversation.com,2011:/uk/topics/peer-to-peer-lending-3197/articlesPeer-to-peer lending – The Conversation2022-10-14T15:01:01Ztag:theconversation.com,2011:article/1857412022-10-14T15:01:01Z2022-10-14T15:01:01ZHow financial technology can discriminate against people speaking minority dialects – new evidence from China<figure><img src="https://images.theconversation.com/files/486575/original/file-20220926-19-h9ub5t.jpg?ixlib=rb-1.1.0&rect=275%2C128%2C5858%2C3099&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/asia-startup-sme-woman-people-happy-2134331077">Chaay_Tee / Shutterstock</a></span></figcaption></figure><p>In the UK, studies have repeatedly found evidence of <a href="https://theconversation.com/working-class-and-ethnic-minority-accents-in-south-east-england-judged-as-less-intelligent-new-research-162886">accentism</a>. Prejudice based on someone’s way of speaking can affect people in the classroom, the <a href="https://theconversation.com/british-people-still-think-some-accents-are-smarter-than-others-what-that-means-in-the-workplace-126964">office</a> and beyond. </p>
<p><a href="https://www.tandfonline.com/doi/full/10.1080/1351847X.2021.2007496">Our research</a> of dialects and peer-to-peer lending in China found that this kind of linguistic discrimination can also influence someone’s access to finance. Specifically, that accent bias, communication barriers or dialect discrimination may lead to borrowers who speak minority dialects receiving smaller loans and having higher default rates.</p>
<p><a href="https://www.bankofengland.co.uk/research/fintech">Financial technology</a> (fintech for short) is the technology and innovation that aims to compete with traditional financial institutions. The emerging industry is an alternative to banks and personal loans, allowing people to lend or borrow money from one another directly. Based online, these companies have <a href="https://pubsonline.informs.org/doi/abs/10.1287/mnsc.2016.2531">lower transaction costs</a> and complement the shortcomings of traditional banking for <a href="https://academic.oup.com/rfs/article/32/5/1900/5427773">small loans</a>.</p>
<p>Discrimination is well documented in traditional financial <a href="https://theconversation.com/how-ethnic-minorities-face-higher-levels-of-financial-exclusion-71960#:%7E:text=Our%20analysis%20found%20that%20ethnic,lower%20compared%20with%20white%20households.">services</a> and there have been ongoing discussions about <a href="https://technation.io/about-us/fintech-delivery-panel/ethnic-diversity-in-uk-fintech/#introduction">diversity</a> in the sector. However, these have focused on more obvious forms of prejudice, such as ethnic or racial bias, while our study shows that this could be broader and more subtle, in the form of dialect discrimination. </p>
<p>People using different dialects often have <a href="https://www.jstor.org/stable/4168582?seq=1">distinct cultural habits</a>, sometimes almost as if they are from different countries. So, if there are multiple dialects in an area, this can lead to communication barriers and, ultimately affect borrowers with different dialects.</p>
<p>China is one of the largest fintech credit markets, with around <a href="https://www.oecd.org/competition/digital-disruption-in-banking-and-its-impact-on-competition-2020.pdf">2,500 platforms</a> supporting peer-to-peer lending. There are 17 major dialects and 105 sub-dialects spoken in the 300 cities in <a href="https://www.taylorfrancis.com/books/mono/10.4324/9780429309588/chinese-mosaic-peoples-provinces-china-leo-moser">China</a>. The pronunciation and grammar in different provinces has developed to an extent that variations of spoken language are often mutually incomprehensible. </p>
<p>My colleagues Zhongfei Chen, Ming Jin, Youwei Li and I <a href="https://www.tandfonline.com/doi/full/10.1080/1351847X.2021.2007496">examined 210,841 historical loan records</a> from one of China’s first online lending platforms, covering the period from 2013-2018. We used this data to explore the links between dialect diversity (the number of dialects spoken in a city) and borrower behaviour.</p>
<p>We found that borrowers from areas where more minority dialects are used received smaller loans when using the fintech platform we studied. They also had higher default rates, compared with borrowers from cities with less dialect diversity. This was the case when comparing people with similar income levels and other characteristics like gender, age, education and credit rating.</p>
<h2>Financial literacy – lost in translation?</h2>
<p>In the platform we examined, borrowers apply for a loan and the company reviews the application before deciding the final loan amount and interest rate. The lending platform plays the role of a third party and does not want borrowers to default. As a result, they treat loan applicants with caution. </p>
<p>With some transactions between users, the approval process all takes place online. But borrowers of certain types of loans (such as those where the platform acts as guarantor) must also pass an in-person review. Reviewers collect data on gender, marital status, work, education, age and income. It is in these reviews, we believe, that accent bias and cultural discrimination can work against borrowers who speak minority dialects.</p>
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<img alt="A sheet of Chinese yuan cash being printed" src="https://images.theconversation.com/files/486577/original/file-20220926-12-gcijga.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/486577/original/file-20220926-12-gcijga.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=356&fit=crop&dpr=1 600w, https://images.theconversation.com/files/486577/original/file-20220926-12-gcijga.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=356&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/486577/original/file-20220926-12-gcijga.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=356&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/486577/original/file-20220926-12-gcijga.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=448&fit=crop&dpr=1 754w, https://images.theconversation.com/files/486577/original/file-20220926-12-gcijga.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=448&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/486577/original/file-20220926-12-gcijga.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=448&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">In examining data from a Chinese peer to peer lending company, researchers found evidence of dialect discrimination.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/concept-image-showing-sheet-new-chinese-1771815803">Inked Pixels / Shutterstock</a></span>
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<p>The link between access to finance and dialect diversity might be due to different levels of <a href="https://gflec.org/wp-content/uploads/2015/11/3313-Finlit_Report_FINAL-5.11.16.pdf">financial literacy</a> and consequently, communication barriers among different dialect users. There is indeed <a href="https://www.sciencedirect.com/science/article/pii/S0167268118300763">evidence</a> linking language to financial literacy. Low levels of financial literacy in China (about 28% of adults, compared to the UK’s 67%), could make communication about loans and finances more difficult among different language users. </p>
<p>The results of our research aren’t entirely surprising. Language and dialect <a href="https://www.thoughtco.com/dialect-prejudice-term-4052385">discrimination</a> are longstanding problems in <a href="https://www.cambridge.org/core/journals/language-in-society/article/linguistic-capital-in-taiwan-the-kmts-mandarin-language-policy-and-its-perceived-impact-on-language-practices-of-bilingual-mandarin-and-taigi-speakers/6F5F262FB1D3F8F3E6F7CCF3BD6F9C07">China</a>. And previous studies have shown that ethnic minorities often experience economic <a href="https://link.springer.com/article/10.1023/B:REAL.0000027199.22889.65">disadvantages</a> compared to other groups.</p>
<p>But our findings show how fintech platforms create a mechanism through which discrimination against minority dialects can arise. This is especially important in a country with such vast income inequality as China. Linguistic differences may be getting in the way of loans flowing to those who need them most.</p><img src="https://counter.theconversation.com/content/185741/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Athanasios Andrikopoulos does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Research into Chinese peer to peer lending data shows that borrowers from regions with more minority dialects receive smaller loans.Athanasios Andrikopoulos, Senior Lecturer (Associate Professor) in Finance, University of HullLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1230242019-09-11T14:34:08Z2019-09-11T14:34:08ZWhy crowdfunding may not be the great democratising force in investment after all<figure><img src="https://images.theconversation.com/files/291959/original/file-20190911-190044-1v20ktn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/crowdfunding-vector-illustration-startup-investment-flat-1271931493">Shutterstock</a></span></figcaption></figure><p>The digital revolution has had a huge impact on the way new and small companies are financed – and <a href="https://www.moneyadviceservice.org.uk/en/articles/crowdfunding--what-you-need-to-know#what-is-crowdfunding">crowdfunding</a> has been at the forefront. In little over a decade, it has emerged to become an important source of funding for entrepreneurs who are increasingly financing their ventures by attracting small amounts of money from large groups of individuals.</p>
<p>Typically this works via a crowdfunding platform such as <a href="https://www.kickstarter.com/about?ref=global-footer">Kickstarter</a>, <a href="https://www.fundingcircle.com/uk/">Funding Circle</a> or <a href="https://www.seedrs.com/">Seedrs</a>, which seek to bring entrepreneurs and investors together. But some businesses make a direct appeal to investors via their own fundraising platforms, such as their website.</p>
<p>Initially, crowdfunding brought great optimism that it would have a “<a href="https://cmr.berkeley.edu/browse/articles/58_2/5812/">democratising effect</a>” on finance. On the one hand it would enable entrepreneurs excluded from traditional sources of finance to attract funding. And, on the other, it would provide new opportunities for people with even relatively modest amounts of money to invest. For example, private investors looking for higher returns than those available with high street banks have been attracted to various lending platforms – also known as <a href="https://www.gov.uk/guidance/peer-to-peer-lending">peer-to-peer</a> (P2P) platforms. </p>
<p>Our <a href="https://www.researchgate.net/publication/334473761_Handbook_of_Research_on_Crowdfunding">work</a> has reviewed the available research on crowdfunding to examine whether this relatively recent method of financing new and small businesses lives up to the lofty claims of democratising investment in the 21st century.</p>
<p>Donation-based crowdfunding platforms have certainly made it possible for lots of not-for-profit projects (such as charity-based ventures and social enterprises) to raise finance from philanthropic investors who are not seeking a financial return.</p>
<p>The types of businesses raising finance from P2P platforms (where lenders provide loans with interest), and equity-based crowdfunding platforms (where entrepreneurs sell a stake to investors), are certainly more diverse compared to those financed by banks, “<a href="https://www.investopedia.com/terms/a/angelinvestor.asp">business angels</a>” and <a href="https://www.investopedia.com/terms/v/vcfund.asp">venture capital</a> funds. </p>
<p>But in other respects, we <a href="https://www.e-elgar.com/shop/handbook-of-research-on-crowdfunding">discovered</a> this democratisation idea can be challenged.</p>
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<h2>Bias, geography, skills and risk</h2>
<p>First, the “crowd” has its own preferences and biases. Some types of projects are less attractive than others. For example, consumer-oriented products and services <a href="https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/shifting-paradigms/#.XXisaShKjIU">work better</a> than science and technology projects. The crowd also engages in herd behaviour – if there is a lack of detailed information and track record for ventures seeking funds, investors will often look at the actions of other investors when making their own investment decisions.</p>
<p>Second, entrepreneurs differ in their ability to access the crowd. This happens in a variety of ways. Often they need to have raised initial finance to get their project off the ground before coming to a platform. Typically this comes from the entrepreneur’s own money and from family and friends. But not everybody has access to these sources. The entrepreneur’s personal networks are also vital, with funding success associated with those who have high levels of engagement on social media such as Facebook and Twitter.</p>
<p>As in the offline world, investors are attracted to entrepreneurs with high levels of “human capital” – skills, experience, understanding of the market – and who are able to signal their credibility, competence and trustworthiness. Entrepreneurs need strong communication skills to successfully raise finance.</p>
<p>Third, crowdfunding has not eliminated the issue of geography. Even though crowdfunding platforms overcome the distance problem by connecting entrepreneurs and investors regardless of where they are, “home bias” is a persistent feature of crowdfunding. Put simply, investors seem to prefer to fund ventures on their doorstep.</p>
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<img alt="" src="https://images.theconversation.com/files/291968/original/file-20190911-190065-h4be9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/291968/original/file-20190911-190065-h4be9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/291968/original/file-20190911-190065-h4be9.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/291968/original/file-20190911-190065-h4be9.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/291968/original/file-20190911-190065-h4be9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/291968/original/file-20190911-190065-h4be9.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/291968/original/file-20190911-190065-h4be9.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Some P2P platforms are already loss-making and returns for investors have fallen.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/crowdfunding-concept-people-inserting-coins-into-1108927925">Shutterstock</a></span>
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<p>And fourth, an emerging concern is that it is no longer just the crowd who are participating on crowdfunding platforms. Both P2P and equity platforms – including some of the UK’s established P2P lenders – are increasingly raising finance from institutional investors, including banks, pension funds, <a href="https://www.investor.gov/introduction-investing/basics/investment-products/mutual-funds-and-exchange-traded-funds-etfs">mutual funds</a> and asset management companies. </p>
<p>A final concern is the risk that investors are exposed to on crowdfunding platforms. Regulators in several countries are <a href="https://www.theguardian.com/business/2016/dec/09/fca-crowdfunding-peer-to-peer-lending">expressing increasing concern</a> that some platforms give a misleading or unrealistically optimistic impression of expected returns, attracting retail investors with little experience or competence to adequately evaluate investment opportunities.</p>
<p>Because of the small amounts they are risking, investors have no economic incentive to undertake due diligence. In fact, most investors are <a href="https://crowdforangels.com/blog/4th-alternative-finance-industry-report/">reported</a> to spend less than 20 minutes per week doing their homework. Crowdfunding platforms also lack governance mechanisms – with entrepreneurial ventures raising finance from numerous individuals, each making small investments, there is little incentive for anyone to monitor the risks. </p>
<h2>Changing the market for good?</h2>
<p>The UK’s <a href="https://www.fca.org.uk/about">Financial Conduct Authority</a> has expressed concern that because the industry is still relatively new it has not gone through a full economic cycle. When economic conditions deteriorate, this could trigger a rise in losses on loans and investments. Several established P2P platforms are already <a href="https://www.altfi.com/article/5511_p2p-lending-returns-compressed-by-rising-losses-since-2016">loss-making</a> and returns for investors have fallen.</p>
<p>Lord Adair Turner, former chair of the UK’s financial regulation body, the <a href="http://thejournalofregulation.com/en/article/financial-services-authority/">Financial Services Authority</a>, has <a href="https://ftalphaville.ft.com/2016/02/11/2152940/the-curious-state-of-uk-peer-to-peer-lending">predicted</a> that the losses emerging from peer-to-peer lending over the next five to 10 years “will make the bankers look like lending geniuses”. </p>
<p>Crowdfunding has undoubtedly changed the market for entrepreneurial finance. But, in contrast to the early optimism, it has not eliminated all of the inequalities encountered by entrepreneurs and investors in traditional financial markets. And what is becoming more apparent is that it has created new sources of inequality and new kinds of risks for investors.</p><img src="https://counter.theconversation.com/content/123024/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>It has undoubtedly been a game-changer for entrepreneurial finance, but researchers are discovering new inequalities and risks for investors.Colin Mason, Professor of Entrepreneurship, Adam Smith business school, University of GlasgowAnnaleena Parhankangas, Associate Professor of Management in the Jerry and Debbie Ivy College of Business, Iowa State UniversityHans Landström, Professor of Business Administration, Sten K Johnson Centre for Entrepreneurship, Lund UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/916452018-02-21T05:59:26Z2018-02-21T05:59:26ZWhy Australia needs a better system for credit scores<figure><img src="https://images.theconversation.com/files/207221/original/file-20180221-5564-obevw7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Lenders will soon have more data on your accounts and cash flow.</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Australia’s credit rating system is failing both borrowers and lenders. Many borrowers are unaware of their own credit scores and <a href="http://sydney.edu.au/business/__data/assets/pdf_file/0004/337459/AGLD-1116-paper_website.pdf">our research shows</a> they have trouble applying for suitable loans. Lenders are also struggling with too little information, causing them to extend loans to those they shouldn’t and restrict loans to worthy borrowers. </p>
<p><a href="https://treasury.gov.au/consultation/c2018-t256276/">Upcoming changes</a> to Australia’s credit reporting system could remedy these issues.</p>
<p>Under the <a href="https://treasury.gov.au/consultation/c2018-t256276/">new credit reporting regime</a>, both lenders and borrowers will have access to more data, such as monthly payment histories on loans and credit cards. This will help consumers understand their own creditworthiness, improve their credit scores and shop around for lower interest rates.</p>
<p>The new data will arm banks and other lenders to make better lending decisions. But it should also level the playing field by giving new entrants more information, helping them to compete with the established lenders. </p>
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Read more:
<a href="https://theconversation.com/forcing-the-banks-to-hand-over-our-credit-history-might-help-with-a-home-loan-but-it-has-risks-86757">Forcing the banks to hand over our credit history might help with a home loan but it has risks</a>
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<p>My <a href="http://sydney.edu.au/business/__data/assets/pdf_file/0004/337459/AGLD-1116-paper_website.pdf">research</a> with Luke Deer examined loan applications to SocietyOne. This is a peer-to-peer lending marketplace that specialises in unsecured personal loans.</p>
<p>Borrowers are only accepted onto the SocietyOne platform if their credit scores can be verified. Substantial “<a href="https://www.investopedia.com/terms/u/underwriting.asp">underwriting</a>” is required to ensure borrowers are of sufficient credit quality. </p>
<p>Underwriting involves evaluating a borrower’s income and cash flow, based on bank statements and other public information. </p>
<p>Despite this labour-intensive and time-consuming process, which requires individuals to submit copies of their documents to third-party lenders, lenders do not receive a complete picture of the potential borrower’s financial situation. </p>
<p>A borrower may report only part of their true financial situation – for example, by sharing information from only one of multiple accounts. Without an accurate picture of creditworthiness, lenders could be extending loans to borrowers that should be rejected, and others might not receive loans they should qualify for. </p>
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Read more:
<a href="https://theconversation.com/business-briefing-what-happens-to-your-credit-history-60247">Business Briefing: what happens to your credit history</a>
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<p>This is where the <a href="https://treasury.gov.au/consultation/c2018-t256276/">new credit reporting regime</a> comes in – there will be much more data. In addition to monthly payment histories, there will be red flags on any missed payments of more than 14 days. The current system only flags missed payments of more than 60 days or bankruptcies only.</p>
<p>Credit reports will include information about current accounts you hold, what accounts have been opened and closed, the date that you paid any default notices, and how well you meet your repayments. </p>
<p>The shift towards comprehensive credit reporting should reduce the time required to underwrite loans and allow loans to be priced more efficiently. This is in part because it will reduce the risk of lending to people who are risky borrowers, and so will <a href="https://www.investopedia.com/terms/a/adverseselection.asp">lower costs</a>. </p>
<p>While this means that borrowers with good credit history will benefit from good behaviour, lower credit quality customers may face higher borrowing costs, or be left searching for alternatives.</p>
<p>But it also opens up more opportunity for borrowers to improve their credit rating by acting on any red flags. </p>
<h2>More innovation ahead in mortgage lending</h2>
<p>Australia has lagged other developed countries in adopting positive credit reporting. Up to this point, the large banks have had a significant informational advantage over new entrants. Because many of us have accounts with the larger banks, they simply had access to information that other lenders don’t.</p>
<p>As well as opening up the market to new borrowers and lenders, the new comprehensive credit reporting regime will also likely lead to the automation of more financial services and the inclusion of more data sources. </p>
<p>For higher-risk borrowers, novel techniques to assess credit risk (such as analysis <a href="http://knowledge.wharton.upenn.edu/article/using-social-media-for-credit-scoring/">of social media</a> accounts) may be the answer to distinguish good borrowers from bad. </p>
<p>This will partially eliminate the need for costly processes in loan underwriting. But prior experience from an <a href="https://academic.oup.com/qje/article/125/1/307/1880343">over-reliance on credit scores</a> in the United States shows that careful assessment of borrowers remains vital. </p>
<p>It could also have the side effect of reducing the prospects of misconduct by either borrower or lender at this stage. </p>
<p>Comprehensive credit reporting should lead to, in aggregate, lower borrowing rates for lower-risk individuals and incentives for higher-risk individuals to improve their position. However, it remains to be seen whether this will lead to a greater degree of exclusion or predatory loans for riskier borrowers.</p><img src="https://counter.theconversation.com/content/91645/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andrew Grant does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Australia’s credit reporting system is about to be updated, and new research shows it’s past due. The current system simply doesn’t provide either lenders or borrowers with enough information.Andrew Grant, Senior Lecturer, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/502292016-01-06T11:02:47Z2016-01-06T11:02:47ZCrowdfunding cool fuels its growth but investors risk a sting in the tail<figure><img src="https://images.theconversation.com/files/107359/original/image-20160106-14935-q4un78.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Happy customer.</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/lhl/15615565234/in/photolist-pMTRvm-kUAvFg-uKPdCx-vqdfLH-vq5RYU-uKDJRQ-gwcD7s-q1Jv1X-q1Auy3-q1JuRD-tSfKWX-o3DZ3n-ojQTEp-AeN6g3-s6FVt8-s4sdLE-rPb5tY-r9K3N5-eWvkzc-gup34G-AeW7et-eWGJUA-eWcLCo-ub2hv1-tesubY-tTSCqw-oMtEUq-ubApS8-eXHUyr-qUsg1E-oUeZ17-nQxPtD-uEomzS-rx85VZ-q3UWUV-nWpom3-tVDSR5-eXHSzp-wFc2p5-eemfuz-eXHSPe-gwdiAF-uxRWRy-jaWUz6-x63MmW-x7Bzqf-wXNL5M-gwd4vC-AD3vSk-qdhGnp">Leonard Lin</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span></figcaption></figure><p>Crowdfunding has rapidly emerged as an alternative source of financing for start-ups and new ventures. From artistic endeavours such as Marina Abramovic’s <a href="https://www.kickstarter.com/projects/maihudson/marina-abramovic-institute-the-founders">Institute project</a> to new tech like the <a href="https://www.kickstarter.com/projects/1523379957/oculus-rift-step-into-the-game?ref=sidebar">Oculus Rift</a> virtual reality headset and the <a href="https://www.kickstarter.com/projects/597507018/pebble-e-paper-watch-for-iphone-and-android?ref=sidebar">Pebble smartwatch</a>, crowdfunding has become increasingly mainstream. </p>
<p>The idea of being part of the business development process has proven popular with individual investors who are able to get on board with projects from the outset. The story-telling features of crowdfunding sites such as <a href="https://www.kickstarter.com">Kickstarter</a> and <a href="https://www.indiegogo.com">Indiegogo</a> also make investors feel personally involved. </p>
<p>The advantages for investors are not just transactional or financial – they get to be part of something. Consequently, crowdfunding has been described as <a href="http://www.ukcfa.org.uk/">democratic finance</a>, placing a strong emphasis on building community while also benefiting from it.</p>
<p>But is it all as good as it sounds? A growing number of <a href="http://gizmodo.com/the-9-most-disgraceful-crowdfunding-failures-of-2015-1747957776">reports</a> show investors failing to get a return. If crowdfunding is to continue growing – and providing an important platform for new start-ups – better transparency and regulation is needed.</p>
<h2>Money and trust</h2>
<p>Crowdfunding allows businesses, particularly start-ups, to access funding via contributions from a large number of unrelated people. In return for these injections of cash, funders are promised various rewards once the product or service is up and running. But without proper regulation, this ultimately involves handing money over to strangers online, with nothing but a promise of a return.</p>
<p>Crowdfunding, then, is open to abuse and can be a risky business for investors. In 2015, for example, a British drone company set a record as the most-funded European Kickstarter project – only <a href="http://arstechnica.com/business/2015/11/after-raising-record-3-4m-on-kickstarter-uk-drone-startup-collapses/">to file for bankruptcy later in the year</a>. Despite raising US$3.4m its collapse left donors out of pocket and without the product they had funded.</p>
<p>Ouya, an Android-based micro games console, is <a href="http://www.trustedreviews.com/opinions/5-big-money-crowd-funding-projects-that-failed">another famous crowdfunding failure</a>. Started in 2013, Ouya reached its US$950,000 Kickstarter fundraising goal within a record eight hours and went on to collect US$8.5m in pledges – more than nine times the initial ask. But fans were underwhelmed by the finished product and in 2015 it was bought by large games house Razer after being crippled by debt. The bottom line is that crowdfunding does not always result in success.</p>
<p>So what to do? The primary responsibility lies with the crowdfunding sites to maintain a transparent and safe platform for their funders. But funders should also do their due diligence on the companies they are investing in.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/107361/original/image-20160106-14944-9vxbld.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/107361/original/image-20160106-14944-9vxbld.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=450&fit=crop&dpr=1 600w, https://images.theconversation.com/files/107361/original/image-20160106-14944-9vxbld.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=450&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/107361/original/image-20160106-14944-9vxbld.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=450&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/107361/original/image-20160106-14944-9vxbld.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=566&fit=crop&dpr=1 754w, https://images.theconversation.com/files/107361/original/image-20160106-14944-9vxbld.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=566&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/107361/original/image-20160106-14944-9vxbld.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=566&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Many backers stopped believing in Ouya.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/silwenae/8750287591/in/photolist-ekevDr-ekWz3C-ekWxsj-ekWzWN-ekQPnF-ekQP6Z-ekQNTX-ekQMc4-ekWxoJ-exYt4r-cqHdGw-cuFMCb-dKabQn-e6W7Qs-e8Hg47-e8BALx-e8BAJX-eBCXkk-eBG95q-eBG8Zb-eBG8Tb-eBCWRg-eBG8zw-e8BABp-e8BArx-e8Hfsw-e8Hfn7-e8HfDA-e8HfAq-e8Hfwq-dKabQ8-dKfF1d-dKfEZ5-dKabNx-dKabNZ-dKfEXb-dKabNg-e8BB8c-eEYrXi-ex1f3Z-f6Kakt-ex4qH7-ex4prw-f5eA9R-euWF7t-hpJTgF-hpJ1hs-dmyrjK-fSsGJM-fFJ9Qz">pcutler/flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span>
</figcaption>
</figure>
<h2>Peer-to-peer pressure</h2>
<p>As an alternative to donation crowdfunding, investment crowdfunding sees money exchanged for securities. Peer to peer (or P2P) lending, for example, allows individuals or companies to borrow money from a range of investors, who they then repay with interest. This, too, needs careful monitoring.</p>
<p>While there are measures in place to monitor crowdfunding activities of this kind – in the UK, by the financial regulatory body, the Financial Conduct Authority (FCA) – losses are not always covered <a href="http://www.ukcfa.org.uk/faqs">under its compensation scheme</a>. And if crowdfunded ventures fail, funders lose their investment. In recent years, a number of P2P crowdfunding platforms have sprung up. But many have since <a href="http://www.p2pmoney.co.uk/companies.htm">filed for bankruptcy and disappeared</a>, taking investors’ money with them.</p>
<p>The good news is that as of February 2015 the FCA proposed tighter regulations to safeguard P2P investors. In a <a href="http://www.fca.org.uk/static/documents/crowdfunding-review.pdf">critical review report</a>, the FCA stipulates that crowdfunding platforms are run with a resolution plan so that repayments can be recovered and investments protected.</p>
<p>Issues remain, however. Between April and October 2015 the <a href="http://www.nabarro.com/insight/briefings/2015/march/fca-reviews-crowdfunding-regulation-regime/">FCA reviewed</a> 25 crowdfunding websites and identified the following key issues:</p>
<ul>
<li><p>Their position on taxation is unclear.</p></li>
<li><p>Annual percentage rates are unclear.</p></li>
<li><p>The benefits are emphasised over the risks associated with crowdfunding.</p></li>
</ul>
<p>And while the FCA has attempted to create a robust framework within which such activities must operate, it remains strangely silent on the issue of intellectual property rights. While those looking for funding don’t want to divulge their trade secrets, investors need reassurance that they are investing in a viable product – and that requires the sharing of a certain level of information. Finding a way to protect both parties is key.</p>
<p>So, while crowdfunding is an innovative way for businesses to get off the ground and will likely continue to grow as a model, a number of issues remain. Investors risk a sting in the tail if they are not careful and it’s important that both crowdfunding hosting sites and the government act to protect them, while helping businesses to grow, too.</p><img src="https://counter.theconversation.com/content/50229/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rama Kanungo does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Crowdfunding has produced start-ups such as Oculus Rift and Pebble watches … but it’s not a success story for everyone.Rama Kanungo, Lecturer in Accounting and Finance, Newcastle UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/517362015-12-03T18:52:43Z2015-12-03T18:52:43ZSizing up the Asia Pacific’s booming alternative finance sector<p>If digital disruptors like crowd-sourced equity funding and peer-to-peer lending platforms are going to transform the finance sector, they need to be regulated. If they are going to create permanent positive change, they need to be regulated intelligently. </p>
<p>But so far, the ability of regulators and industry to agree on the rules has been hampered by a significant knowledge gap: there is no accurate, up-to-date information about the size, scale and scope of the rapidly growing online alternative finance sector in our region.</p>
<p>The University of Sydney Business School has joined forces with the United Kingdom’s University of Cambridge and Tsinghua University in China, to conduct the first comprehensive survey of the rapidly expanding alternative finance sector in China and across the rest of the Asia-Pacific. </p>
<p>Building on a successful 2015 benchmarking survey of the UK and Europe, the Asia-Pacific survey will run through to mid December 2015. By early 2016, we will have aggregate information about the various types of online platforms, the overall size and recent growth of the alternative finance sectors in Australia, New Zealand, Singapore, China and other Asia-Pacific neighbours.</p>
<p>Why is aggregate data on crowd-sourced and peer-to-peer finance so critical? Uninformed regulation can indeed be harmful — so why regulate at all? Direct connection between lenders and borrowers, or donors and causes, is part of the attraction of alternative finance, and that’s all between consenting adults after all. But it’s the “peer-to-peer” feature of these markets that calls for intelligent regulation.</p>
<p>Naïve ideology sees all regulation as anathema to free markets. In reality, most markets can’t function without it. Efficient markets depend on reliable information about product quality being shared between buyers and sellers, as Nobel prize winner George Akerlof demonstrated in his analysis of the used car market - his famous work on the “market for lemons”. </p>
<p>If buyers can’t tell whether they are buying a good car or a lemon they will never pay what a good car is worth. Owners of good cars will not offer their cars for sale and eventually only lemons will be left. Markets with this unequal information problem are likely to collapse without minimum quality guarantees.</p>
<p>In crowd-funded and peer-to-peer finance markets, the borrower knows much more about their ability to repay than the lender does. Minimum credit worthiness standards for borrowers, some limitations on risk exposure for unsophisticated lenders, and effective disclosures are needed for the survival of these platforms.</p>
<p>Take peer-to-peer lending for example. In conventional lending markets an intermediary like a bank transforms the deposits of lenders into loans for borrowers. Intermediation turns one person’s bank deposit into another person’s loan but no individual depositor cops a direct hit if a particular borrower defaults; the intermediary bears this risk. Of course, banks charge for the service of disconnecting lenders from the risk of individual borrowers. </p>
<p>This charge partly accounts for the (at least 10 percentage points) difference between term deposit rates and personal loan rates.</p>
<p>Peer-to-peer lending uses a direct connection between lenders and borrowers. This allows the platform to shrink the difference between lending and borrowing rates. Someone wanting a $5,000 loan for a holiday might register with a peer to peer platform. If they default on their repayments, whoever lent them the money bears the loss. While the average default rate across all loans on a peer-to-peer lending platform in normal times might be low – say less than 3% - the actual outcome for each lender depends on the specific borrowers they lend to and economic conditions at the time.</p>
<p>Without some minimum guarantees and lender protections, interest rates and charges are likely to rise as poor quality borrowers (lemons) drive out good quality borrowers, and the market will collapse. Similarly, the crowd-sourced equity platforms that can enable brilliant and highly profitable new ideas (so-called “unicorns”) to find capital depend on regulatory protection for unsophisticated investors. Stability, sustainability and trust are needed so we can all benefit from the accessibility and efficiency of this digital disruption.</p>
<p>Most alternative finance providers now operating in Australia are well aware of the need for sustainable business practice. Peer-to-peer lenders, for example, check the credit worthiness of borrowers in conventional ways, using credit history, capacity to pay, and sometimes secured assets. The platforms usually spread lenders’ funds across a range of borrowers, and facilitate payments and repayments.</p>
<p>However minimum regulatory guidelines ensuring good practice will protect the sector from “fly-by-night” entrants with lower standards. Setting those minimum standards well can only be done with comprehensive data on the alternative finance sector. </p>
<p>We don’t want to lose or delay the benefits of digital disruption in finance simply because not enough is known about the structures and participants.</p><img src="https://counter.theconversation.com/content/51736/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Susan Thorp does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Our region’s peer-to-peer lending sector is sharply expanding, so regulators will need to grapple with it.Susan Thorp, Professor of Finance, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/388362015-03-29T19:02:29Z2015-03-29T19:02:29ZWhat you need to know about peer-to-peer lending<figure><img src="https://images.theconversation.com/files/75778/original/image-20150324-17693-1tfjbwn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Alternative sources of information about an individual's behaviour provide new opportunities for credit assessment.</span> <span class="attribution"><span class="source">Image sourced from shutterstock.com</span></span></figcaption></figure><p>Peer-to-peer (P2P) lending is a fast developing market for individuals and <a href="http://www.smh.com.au/business/property/thincats-site-launches-20141202-11yacd.html">small businesses</a> looking to lend or borrow money. It has the potential to challenge the dominance of traditional financial institutions like banks, but involves new risks for both lenders and borrowers.</p>
<p>In its simplest form, P2P uses a web platform to connect savers and borrowers directly. In this form, the saver lends funds directly to the borrower. Few providers offer such a “plain vanilla” product. A P2P platform matches individuals using proprietary algorithms. It works like a dating website to assess the credit risk of potential borrowers and determine what interest rate should be charged. It also provides the mechanics to transfer the funds from the saver to the borrower. The same mechanics allow the borrower to repay the money with interest according to the agreed contract. </p>
<p>Local players in the P2P market (not all yet operational) include Society One, RateSetter, Direct-Money, ThinCats and MoneyPlace. </p>
<p>There are many ways that the basic framework can differ. This affects the types of risk faced by both lenders and borrowers. Protecting the borrower’s identity from the lender is important. What if the lender is a violent thug who takes umbrage if payments aren’t met? Protecting the borrower brings another risk. The lender must rely on the operator to select suitable borrowers and take appropriate action to maximise recoveries.</p>
<p>The operator can provide a wide range of services. For example, lenders might have a shorter time frame than borrowers, or discover that they need their funds back earlier than they thought. The operator may provide facilities to accommodate that. Or, rather than lenders being exposed to the default risk of a particular borrower, the operator may provide a risk-pooling service, whereby exposure is to the average of all (or some group of) loans outstanding.</p>
<p>The further these services extend, the more the P2P operator starts to look like a traditional bank – but not one reliant on bricks and mortar, nor on the traditional mechanisms of credit analysis relying on customer banking data. The explosion of alternative sources of information (including social media) about an individual’s behaviour, characteristics, and contacts for instance, provide new opportunities for credit assessment analysis based on applying computer algorithms to such sources of data.</p>
<p>While the traditional three C’s of loan assessment (character, collateral, cash flow) remain important, new data and ways of making such assessments are particularly relevant to P2P operators. Indeed P2P operators go beyond the credit scoring models found in banks in their use of technology and data, unencumbered by the legacy of existing bank technology and processes. It is partly this flexibility which explains their growth overseas and forecasts of substantial market penetration in Australia. Much of that growth can be expected to come from acceptance by younger customers of the technology involved – and about whom there is more information available from social media to inform credit assessments. </p>
<p>But also relevant is, of course, the wide margins between bank deposit interest rates and personal loan rates. With - arguably - lower operating costs and ability to match or better bank credit assessment ability, P2P operators are able to offer higher interest rates to lenders and lower rates to borrowers than available from banks. </p>
<p>For lenders, higher interest rates are offset to some degree by the higher risk to their funds. Unlike bank deposits, P2P lenders bear the credit risk of loan defaults – although P2P operators would argue the risk can be relatively low due to good selection of borrowers and mechanisms for enabling lenders to diversify their funds across a range of borrowers.</p>
<p>For borrowers, the main risks arise from the consequences of being unable to meet loan repayments. There is little experience available in the Australian context to understand whether P2P operators will respond to delinquencies by borrowers in a different manner to banks. </p>
<p>It’s important that P2P isn’t confused with payday lending where low income, high credit risk, borrowers unable to meet repayments can quickly find themselves in dire straits by rolling over very short term loans at high interest rates.</p>
<p>The two business models can overlap – with payday lenders offering loan facilities via web based platforms. One challenge for P2P operators is to ensure the community and regulators accept their model as one of being responsible lenders to credit worthy clients. They also need to convince regulators that these unfamiliar business models do not pose unacceptable risks to potential customers. </p>
<p>P2P lending could have major benefits to individuals who want to invest, lend or borrow money. Hopefully regulators will be able to distinguish between good and bad business models. If they can’t, they could prevent a profound challenge to traditional banking.</p><img src="https://counter.theconversation.com/content/38836/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Davis does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Peer-to-peer (P2P) has the potential to challenge the dominance of traditional financial institutions like banks, but involves new risks for both lenders and borrowers.Kevin Davis, Research Director, Australian Centre for Financial Studies Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/369962015-02-04T05:59:00Z2015-02-04T05:59:00ZA wave of financial tech firms is shaking up the world of banking<figure><img src="https://images.theconversation.com/files/70968/original/image-20150203-25561-rypua0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Technology is changing finance in ways Jefferson would never have imagined.</span> <span class="attribution"><span class="source">Marie Shearin Images/Shutterstock</span></span></figcaption></figure><p>Digital technology and pervasive access to the internet have reshaped many industries, and banking is no exception: <a href="http://www.hampdenandco.com/">Hampden and Co</a> is the latest in a short but growing list of <a href="http://www.computerweekly.com/news/2240238535/Six-challenger-banks-using-IT-to-shake-up-UK-retail-banking">digital-only banks</a> built not of bricks and mortar, safes and strongboxes, but which instead operate entirely virtually in the realm of cloud computing.</p>
<p><a href="http://thefinanser.co.uk/fsclub/2012/06/fidor-bank-from-one-extreme-to-another.html">Fidor Bank</a> in Germany implements web 2.0, e-commerce and gaming features together with mobile internet access to provide a seamless service. From the adoption of <a href="http://www.coindesk.com/fidor-becomes-first-bank-to-use-ripple-payment-protocol/">virtual currency payments</a> to <a href="http://www.ft.com/cms/s/0/4eea4798-81c6-11e3-87d5-00144feab7de.html">Facebook campaigns</a> to increase interest rates for savers, Fidor Bank is a great example of how the banking industry is being shaken up.</p>
<p>Historically the banking sector was innovative, but has become moribund. Mainstream banking in developed economies has dragged its heels to adopt new services, in part due to the inflexibility of their legacy information systems. </p>
<p>But the wave of changes that followed the 2008 financial crisis has put pressure on the sector to meet more stringent requirements of transparency and consumer choice. At the same time, the availability of increasingly cheap cloud computing and storage, business analytics and speedy mobile internet on smartphones allows for the creation of new businesses that were unthinkable only a few years ago.</p>
<h2>Re-inventing the wheel</h2>
<p>So while the big banks are taken to task for their lack of innovation and dull or unreliable online services, a new landscape is being carved out by smaller competitors and other financial services companies. Known as “fin tech” firms, they are upping the game and driving change faster through the otherwise staid financial services industry. For example, in the UK:</p>
<ul>
<li><p>Crowdfunding sites that help entrepreneurs to raise cash from the public in forms of donation, and rewards (<a href="https://www.kickstarter.com/">Kickstarter</a>, <a href="http://www.indiegogo.com">Indiegogo</a>, <a href="https://www.crowdfunder.com/">Crowdfunder</a>) or even equity (<a href="https://www.crowdcube.com/">Crowdcube</a>, <a href="https://www.seedrs.com/">Seedr</a>).</p></li>
<li><p>Peer-to-peer lending platforms, which matches lenders to individual borrowers (<a href="http://www.ratesetter.com/">Ratesetter</a>, <a href="http://www.zopa.co.uk">Zopa</a>) or companies looking for cash to invest or expand (<a href="https://www.fundingcircle.com/">Funding Circle</a>), or those creating a new marketplace for mortgages (<a href="https://www.lendinvest.com/">LendInvest</a>). </p></li>
<li><p>Online investment tools for wealth management (<a href="http://www.nutmeg.com/">Nutmeg</a>)</p></li>
<li><p>Currency trade systems based on mobile and cloud technology (<a href="https://www.currencycloud.com/">The Currency Cloud</a>, <a href="https://transferwise.com/">TransferWise</a>).</p></li>
</ul>
<p>Take the example of booming crowdfunding and peer-to-peer lending, an industry worth <a href="http://www.computerweekly.com/news/2240239246/UK-peer-to-peer-lending-exceeded-1bn-in-2014">£1.2 billion in the UK</a>. Peer-to-peer lending is a way of obtaining a loan via small contributions from a large number of lenders. It relies on online platforms that, together with powerful algorithms for risk analysis and tools to connect with social media channels, can bring together funders who spread over various geographical locations. In part, its digital only strategy makes this business viable, as this significantly reduces the cost of communicating and accessing information about both lenders and borrowers’ reputation and credit reliability.</p>
<p>These fin tech companies are great examples of how digital tech is being put to new uses, in stark contrast to most established banks. The lack of large legacy systems is an advantage, as adjustments to new features of their products or services can be performed rather quickly and with more agility. Of course they do not also rely on retail locations, large physical offices, or even buying and maintaining their own hardware.</p>
<h2>The future of digital banking</h2>
<p>How likely is all this to shake up the established order? Recent <a href="http://www.nesta.org.uk/publications/understanding-alternative-finance-uk-alternative-finance-industry-report-2014">figures from Nesta</a> show the crowdfunding market more than doubled to £1.74 billion between 2013 and 2014, but this is only 2.4% of the business lending market. </p>
<p>However, even if the niches that fin tech companies colonise do not seem to directly threaten established financial companies, they introduce alternatives to well-established ways of doing business. Perhaps one of the <a href="http://www.computerweekly.com/news/2240234889/80-of-Brits-trust-new-banks-if-they-have-good-technology">biggest threats</a> comes from digital giants such as Apple, Google or Facebook who are moving into the financial sector, either with new products or by acquiring fin tech start-ups.</p>
<p>Technology and new businesses also challenge assumptions about how financial services might be governed and regulated in the future. For the most part the boundaries between regulated and unregulated practices are not disputed. However, recent responses to virtual currencies such as Bitcoin and the financial advisory functions of some firms seem to prompt national and international regulators for a response.</p>
<p>These new businesses and their models could develop in a number of different ways. They could be largely absorbed into established elements of the financial sector, however reformed, through acquisition or by becoming part of a value chain with established firms. Alternatively, fin tech firms could extend their services to challenge the high street banks, aiming to become the answer to the criticisms levelled at today’s financial services sector. </p>
<p>In any case 2015 is, like recent years, shaping up to be a very active and interesting year for a sector where change is not generally kindly regarded.</p><img src="https://counter.theconversation.com/content/36996/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Carla Bonina received funding from the RCUK under the NEMODE programme in 2013-14 to conduct part of her research work into fin tech and new business models in the UK. </span></em></p>Digital technology and pervasive access to the internet have reshaped many industries, and banking is no exception: Hampden and Co is the latest in a short but growing list of digital-only banks built…Carla Bonina, Lecturer in Entrepreneurship and Innovation, University of SurreyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/370002015-02-02T06:13:35Z2015-02-02T06:13:35ZGoldman prepares to muscle in on the lending innovation designed to sideline banks<p>Peer-to-peer lending, the online platforms which allow you and I to lend directly to people and businesses who want to borrow, <a href="http://www.nasdaq.com/article/peertopeer-lending-grows-as-a-disruptive-force-in-finance-cm387035">has been hailed as disruptive technology</a>. 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.</p>
<p>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, <a href="http://p2pfa.info/peer-to-peer-lending-surpasses-1-billion-in-2014">according to the trade body</a>, Peer2Peer Finance Association. Although these totals are as yet still a tiny proportion of the UK’s <a href="http://www.bankofengland.co.uk/statistics/documents/mc/2014/dec/moneyandcredit.pdf">£170 billion consumer credit market</a>, this could change fast.</p>
<p>Its credentials as a game-changing industry prompted the Bank of England’s <a href="http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/9749573/Crowdfunding-could-revolutionise-lending-says-Andrew-Haldane.html">Andrew Haldane to suggest</a>: “The banking middle men may in time become the surplus links in the chain.” However, following news that the giant investment bank Goldman Sachs <a href="http://www.ft.com/cms/s/0/93837c4a-a6db-11e4-9c4d-00144feab7de.html#slide0">may be poised</a> 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.</p>
<h2>Can’t beat em? Join em</h2>
<p>Banks are themselves becoming major lenders on some P2P platforms. <a href="http://www.forbes.com/sites/groupthink/2014/10/14/the-disappearance-of-peer-to-peer-lending/">For example, Forbes estimates</a> that in the US, 80-90% of the capital lent through the two largest P2P lenders, <a href="https://www.prosper.com/">Prosper</a> and <a href="https://www.lendingclub.com/">LendingClub</a>, is now institutional money. </p>
<p>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.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/70666/original/image-20150130-25921-1i0jehn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/70666/original/image-20150130-25921-1i0jehn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/70666/original/image-20150130-25921-1i0jehn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=450&fit=crop&dpr=1 600w, https://images.theconversation.com/files/70666/original/image-20150130-25921-1i0jehn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=450&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/70666/original/image-20150130-25921-1i0jehn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=450&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/70666/original/image-20150130-25921-1i0jehn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=566&fit=crop&dpr=1 754w, https://images.theconversation.com/files/70666/original/image-20150130-25921-1i0jehn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=566&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/70666/original/image-20150130-25921-1i0jehn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=566&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Dark days of packaged debt.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/respres/2539334956/in/photolist-4SoKPb-6NpwmK-6NtFPA-oowjJY-7MknKC-a8mMho-8Q4jA8-6CfXf8-c81hoA-6RbPXs-53jDaM-7b93oj-c7USzm-en8Kaz-7fpLCi-aVs7TH-5NuUxU-aVs7Ta-5Yznk1-76uHf6-7ftD8W-7ftCH1-c81mBJ-bdRTci-7fpLok-bdRT7a-peZ55S-5qCzgW-c7VYkJ-c7URmS-c81fBE-c7Xqej-c81jAC-c81kUj-c81hZb-c81iLo-c7YPYm-c7W3kL-c81eUo-c81gzC-c81pPb-c81k5G-5YSqRa-4juU3F-82yEZ1-en5w3D-enEdno-fuei84-64Vnz9-4v6SJo">Jeff Turner</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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</figure>
<p>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 <a href="https://sites.google.com/site/sparemoments/my-articles/cdos---their-role-in-the-financial-crisis">US mortgages were repackaged and traded</a> prior to the 2007 global financial crisis.</p>
<h2>Showing some maturity</h2>
<p>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.</p>
<p>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. </p>
<p>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.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/70644/original/image-20150130-25917-h2m1ko.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/70644/original/image-20150130-25917-h2m1ko.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/70644/original/image-20150130-25917-h2m1ko.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=401&fit=crop&dpr=1 600w, https://images.theconversation.com/files/70644/original/image-20150130-25917-h2m1ko.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=401&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/70644/original/image-20150130-25917-h2m1ko.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=401&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/70644/original/image-20150130-25917-h2m1ko.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=504&fit=crop&dpr=1 754w, https://images.theconversation.com/files/70644/original/image-20150130-25917-h2m1ko.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=504&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/70644/original/image-20150130-25917-h2m1ko.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=504&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">A bank run. Of the rather polite variety.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/56701337@N00/1381147486/in/photolist-373K2G-373K3A-9coGW-avVyLp-7cPKpZ-731wfH-okWyKT-5UQST8-2stuhK-6jyg5-6P3fcJ-6CoTvh-p3WkKV-cTuvhf-7M7htd-3Puau4-5UVcFA-9ULPq-4DRwuD-73k5zB-oE6Kgt-7DmfrL-nAQTwf-8Dcgs3-41C9hm-nbz9fL-41xXrz-7BobUu-73p3fQ-37Y9pm-4RZjFd-4RSt8j-7oNcSU-7oNd5u-cTuDRA-7cTDLL-76ZCNr-4Wzt4W-4RZiZ7-6PFPnC-6N5X4m-7DgutN-6jBEF8-3JABb9-9mwQso-grdpFP-6GFWaA-4RNg8M-4RSugC-cTuh1G">David Farrer</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
</figcaption>
</figure>
<p>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, <a href="http://www.economist.com/node/9832838">as seen at Northern Rock in 2007</a>). Confidence is underpinned by deposit protection schemes – for example, in the UK, <a href="http://www.fscs.org.uk/what-we-cover/eligibility-rules/compensation-limits/deposit-limits/">savers can get back up to £85,000</a> of deposits from the industry-funded Financial Services Compensation Scheme.</p>
<h2>P2P’s USP</h2>
<p>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). </p>
<p>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. </p>
<p>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.</p>
<p>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.</p>
<p>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.</p><img src="https://counter.theconversation.com/content/37000/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jonquil Lowe does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>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…Jonquil Lowe, Lecturer in Personal Finance, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/75852012-06-27T20:41:47Z2012-06-27T20:41:47ZCould peer-to-peer lending challenge our banks?<figure><img src="https://images.theconversation.com/files/11669/original/4m553yjt-1339566876.jpg?ixlib=rb-1.1.0&rect=9%2C3%2C1008%2C797&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Could online peer to peer lenders compete with major banks?</span> <span class="attribution"><span class="source">Flickr: Alan Levine</span></span></figcaption></figure><p>In a recent speech, Bank of England executive director <a href="http://www.bankofengland.co.uk/about/Pages/people/biographies/haldane.aspx">Andy Haldane</a> has said that peer-to-peer (P2P) lending through online sites has the potential to <a href="http://www.guardian.co.uk/business/2012/jun/10/peer-to-peer-lenders-future-of-banking?newsfeed=true">eventually replace old-fashioned banking</a>. It was followed by a recent announcement by the British government that it would channel 100 million pounds to small business through alternative banking channels such as P2P.</p>
<p>This demonstrates the frustration of the Bank of England and the British government with the mainstream banks, which failed the ordinary taxpayer in recent years and were unwilling to cater to small loan needs. For example, as I write, a 100 billion euro (A$126 billion) Spanish banking bailout has been approved. The US bank bailout was estimated at approximately US$700 billion.</p>
<p>No wonder taxpayers ask: are banks a necessary evil that one has to put up with, or is there an alternative?</p>
<p>Why do we need banks? Why can’t we lend to each other? Just as we may borrow from friends and relatives, can we not borrow from and lend to strangers? Is there an alternative to old-fashioned banking, as Andy Haldane calls it?</p>
<p>The good news is an online alternative that could take on the banks - at least in the sphere of small loans - is emerging. It is called P2P lending.</p>
<p>The concept is simple. If you have surplus funds, then instead of making a bank deposit, you lend it through an online intermediary (such as <a href="http://uk.zopa.com/">Zopa</a> in the UK), who would identify a borrower or a group of borrowers to whom the money would be lent and vice versa.</p>
<p>It is an online market place for money similar to eBay. Organisations such as Zopa (for personal loans) and <a href="https://www.fundingcircle.com/">Funding Circle</a> (for small business loans) work on a margin of about 1.8 to 2.3% of the loan. For example, for a three-year fixed rate personal loan of 5,000 pounds, the lender gets a return of about 5 to 5.5% net, while the borrower is charged 7.3% interest. Zopa charges the margin for finding and screening borrowers. It claims that default rates are less than one per cent.</p>
<p>For a similar loan, mainstream banks such as Lloyds TSB and Royal Bank of Scotland (RSB) charge 11.1% and 17.9% interest respectively to the <a href="http://www.moneysupermarket.com">borrower online</a>. Remember that these banks together received a bailout from British government of the order of $ 88 billion, approximately taking the British government’s stake in these banks to 43% and 84% respectively.</p>
<p>The advantage for the lenders through Zopa is higher return as compared to what one may get on alternate savings avenues which is about 3 to 3.5%. How does organisations like Zopa, afford to charge such low interest rates? It is because of the low-cost online model claims Zopa.</p>
<p>Are there Australian equivalents of Zopa? A web search shows that there are at least three P2Ps in Australia, such as the <a href="http://lendinghub.com.au/">Lending Hub</a>, <a href="https://www.igrin.com.au/default.aspx">iGrin</a>, and <a href="https://fosik.com.au/">Fosik</a>.</p>
<p>The Lending Hub states that “the interest rate on loans placed on Lending Hub are determined by the aggregate of bids placed by lenders (as long as the interest rate bid is under the borrower’s set maximum interest rate)”.</p>
<p>The Hub also charges a fee to borrowers from 1.25% to 4% and to lenders from 1% to 3%. Borrowers are also charged an application fee of $30. There is also a direct debit processing fee and late payment fee of $40.</p>
<p>So is P2P the answer? Can they take on our mainstream banks?</p>
<p>Though prima-facie, the idea of social finance or P2P banking looks attractive, there are a number of hurdles in the way. One would need to compare how does the lending through P2P which involves default risk and liquidity issues for the lender stacks up against having a simple bank deposit account which incidentally is now risk free (there is government deposit guarantee of up to A$250,000 per person per deposit-taking institution).</p>
<p>The P2Ps are really operating in small loans space. Though for loans of 5,000 British pounds the comparisons as indicated above may look attractive, as the amount grows P2P players are expensive as compared to mainstream banks. For example, when I keyed in the data for a loan of 7,500 British pounds for three year term, Zopa returned a headline rate of 7.2 per cent while Derbyshire building society showed a rate of 6 per cent and HSBC 6.2%. For a loan of 10,000 British pounds, Zopa rate was not available. Similar comparisons are not possible in Australia as <a href="http://www.mozo.com.au">Mozo</a> – the comparative interest rate website did not return Australian P2P comparative with banks for personal loans.</p>
<p>Unlike in mainstream banking where banks bear the risk of default, in P2P, risk of default is borne by the lender who relies on the credit screening done by the P2P intermediary like Zopa.</p>
<p>IGrin states that it looks after “all of the contractual, payment and collection processes” but, if the borrower fails, what recourse does the lender have against the borrower or the P2P? From the information available at the website of some of the P2Ps, it remains unclear.</p>
<p>Once a loan is given through a P2P intermediary, there is no access to the money if the lender wants it back. Instead, if the lender keeps a deposit with a bank, there is no liquidity issue for the lender as the amount is readily accessible.</p>
<p>It is envisaged that they are “money eBays” - a market place for money. But in eBay one sees the product and then bids. In the ‘money’ e-bays, one puts full trust on the P2P. Trustworthiness of the P2P is therefore a major issue from lender perspective.</p>
<p>There are other hurdles in the way of P2P, which appear to have put a break on the expansion of these organisations. The investigation by Securities and Exchange Commission in the practices followed by Prosper – a P2P in the US – is a pointer. It is reported that borrowers rated as ‘A’ by Prosper had defaulted.</p>
<p>As reported in British media, the government of that country is considering channelling 100 million pounds through alternative banking channels including P2P. Governments routing funds through Zopa or Funding Circle seems attractive, but it remains to be seen what modalities are proposed. There may be a need to register such organisations since government funding may make P2P’s mushroom everywhere. Again, government assistance is unlikely to be without cost, which means cost to the ultimate borrower would increase.</p>
<p><strong>What is the future for P2P lending?</strong></p>
<p>P2Ps can operate in a space which is not filled by mainstream institutions; that is, microloans which range anywhere between $1,000 to $10,000.</p>
<p>Banks find that the operational and monitoring costs of such loan are high, so it doesn’t make economic sense for the banks to fund such microloans unless the interest rate is high. Commonwealth Bank, for example, charges interest rate exceeding 17% when it comes to small personal loans of $5,000.</p>
<p>Similar problems are likely to be faced by existing P2Ps when the volume of business grows.</p>
<p>It’s no wonder that despite some years of existence, the P2P concept has not really taken up in a significant way. eBay and money eBay are not the same thing, after all.</p><img src="https://counter.theconversation.com/content/7585/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Milind Sathye is Professor of Banking and Finance at the University of Canberra and a former central banker.</span></em></p>In a recent speech, Bank of England executive director Andy Haldane has said that peer-to-peer (P2P) lending through online sites has the potential to eventually replace old-fashioned banking. It was followed…Milind Sathye, Professor of Accounting, Banking and Finance, University of CanberraLicensed as Creative Commons – attribution, no derivatives.