Wednesday, April 20, 2011

The changing face of banking- Growth of Social and P2P lending Platforms

Have you ever visited Zopa, Prosper, and Lending Club? For the uninitiated, these are some of the front-runners in the ‘rapidly’ evolving world of P2P (aka Social) Lending.
Peer to Peer lending goes by many names. It is also called social lending, person-to-person lending or p2plending. However, It can be defined in a very simple way: individuals lending money to other individuals through a platform without a banking intermediary.

P2p lending sites hope to disintermediate banks and get credit flowing to individuals and small businesses.

EBay + Facebook = Social Banking  

These sites can be considered a combination of eBay and a place where consumers come together to loan and borrow money from each other. The success of these web-based P2P lending communities can be assessed by the high growth in their numbers and loan volume.

First some numbers:
·         Zopa, which started in the UK in March 2005, has originated 150 million GBP by Mar 2011.
·         Funding Circle, a business-focused P2P lending site, launched in August 2010, originated over £1m in loans in its first ten weeks and is now regularly issuing loans~ $3m per month.
·         In the US, has originated $200m  till date, and Lending Club is now originating more than $15m loans per month and was named as one of the top private companies to watch in 2010.
·         Leading venture capitalists have invested hundreds of millions in various P2P lending models.
o Prosper, $57 million  from Accel Partners, Omidyar Network, Benchmark Capital, etc
o Lending Club attracted $52m funding from Canaan Partners, Foundation Capital, Northwest Venture Partners
o   Zopa received $34 million VC funding from Bessemer Venture Partners, Benchmark Capital, and Wellington Partners and has expanded to Italy and Japan.

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The P2P lending Platform –Value Net

The lending platform or the Exchange has several roles:
First, the exchange creates the meeting place for a sufficient number of investors and investees to gather.
Second, the exchange establishes the legitimacy and investment rating of borrowers in a consistent and transparent manner.
Third, the exchange manages the process of splitting and distributing each investor’s funds in a cost effective and efficient manner. The exchange also provides other services such as insurance to investors or collection services.

Why is Peer to Peer Lending Becoming Popular?
Peer to peer lending is a rapidly growing industry. In2010, the U.S. market processed over $150 million in loans through the two leading Peer to Peer lenders- Lending Club and Prosper. In the first quarter of 2011, year over year numbers were up close to100%. Clearly they are becoming more and more popular with every passing day.

Wall Street Journal Names to 2011 "The Next Big Thing" List, One of Top 50 Venture-Backed Companies

If you carefully study the innovation in banking, the primary products have not changed much since the Italians were the prominent merchants and financiers in the 15th century.

While the popularity and the ubiquity of the Internet are certainly major factors driving the peer-to-peer lending market forward, there are also very clearly significant macro and micro economic factors propelling this business forward. 
Due to tightened credit standards by Financial Institutions, it is becoming difficult for many consumers to acquire non-collateralized personal loans, thus making them considerably more expensive.
Now, this has thus created an opportunity for individual lenders to step in and fill the small loan lending gap, fuelling the current hyper-growth we are currently experiencing in the peer-to-peer lending market.

Peer-to-peer lending also offers significant benefits to both borrowers and lenders. The borrower gets funds at lower rates; those typically range from 10% to 16%, which compares very favorably to credit card advances, often priced over 25% annually or short-term consumer loans, often made at over 100% interest per year. Lenders benefit from higher returns on their idle cash deposits, which can range from 2% -3.5%.
Of course, actual default rates remain to be seen, but the combination of a relatively stable (market-neutral) asset class, that pays higher yields compared to both dividends and bonds is going to be appealing to many individuals.
What we are seeing is the emergence of a new individual-to-individual asset class.

The Opportunity: Although this chart has numbers until 2004 (sorry could not get the figures for 2010 and Non-US markets), the opportunity is staring right in our face. 

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P2P Lending current state: has done a phenomenally good work in compiling together the current state of selected P2P Lending companies.

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So what's next?
While a mass market P2P breakthrough is still not there, the Facebook', Amazon's or Apple's of lending may just be around the corner. Lending Club and Zopa have successfully navigated the challenges of customer acquisition and regulatory compliance.

Most P2P companies are in the early formative stages. While several are expanding rapidly, several have failed. For a sustainable success, P2P Lending industry requires execution in the following areas:
1.Capital Adequacy and Compliance with regulations. Currently, P2P Lending Marketplace companies are not subject to reserve requirements. However, they are subject to minimum working capital requirements. got the SEC license for consumer credit after it was stopped from issuing fresh securities. 
2.Customer acquisition and marketing Model
3.Calibrate Borrower/Lender symmetry (the balance between borrowers’ and lenders’ needs)
4.Risk & Credit Underwriting  Models. Although some risk baked in the pricing model, they need to be strengthened-Credit rating, Diversification, Peer Pressure, Default Cover, Payment Protection cover, etc.)
5.Collections support in case of defaults or Outages.
6.Scalability of business models for large institutional lenders to participate. Institutional investors have already started showing a lot of interest in this new ‘asset’ class. Please read this interesting story in the American Banker 

Lessons for Banks:
Social networking Web sites will affect banks more than we think. Social banking, an emerging banking distribution model, has the potential to displace banks from the center of customers' financial services relationships. The growth of social networking and the emergence of social-banking models will drive fundamental change in the ways that consumers manage their financial lives.

Therefore, Banks must create a social media strategy before deciding to evolve toward a social banking model. They should evaluate opportunities to build partnerships with Digital lending /P2P Lending or banking providers – rather than building their social networks -for example, SmartyPig and  Wesabe, etc.

The best approach to getting over the fear of the unknown is for organizations to become familiar with the risks and then develop a strategy that fits the organization's risk appetite. Doing nothing and ignoring the influence of social media is no longer an option and may be considered a form of negligence.

According to Gartner “Non-bank competitors are pushing aggressively into banking and investment services, threatening to undermine banks in the financial relationship.  The threat is particularly pronounced in two businesses that are at the very heart of banking, namely lending and payment.” Venture capital investment in financial social networks (FSNs) such as Zopa, Prosper and Lending Club, point to the growing prevalence of FSNs and increasing consumer interest in this area.

In summary:
P2P marketplaces have the potential to change the way people borrow and lend money. They provide a democratic, off-the-grid alternative to the consumer credit matrix. However, these firms are still in their early stages, but they're promising. 

At present, these websites work for relatively small, unsecured, and primarily personal loans. With maturity, we are likely to see portfolio diversification e.g., mortgages for homeowners to finance purchases or refinances. Such sites could ultimately supplant the existing financial institutions.

As a response, the incumbent financial institutions should look at either starting their own lending marketplaces or should partner with the niche P2P lending marketplaces.
Well, this is just getting started……I bet there will be a lot of action in this space.

What happens, if Facebook becomes a bank? I will write about this and the future of Social banking in my next post. 
So what do you think? Please do leave your comments.


Anonymous said...

Great article.


P.S: One of the links pointing to p2p-banking seems broken.

Gaurav Sharma said...

Thanks Mike, fixed it :-)

Simon Dixon said...

Great Article.

Peer to Peer is really moving strong. Prosper just announced record loans for the first quarter of 20111.

I just released a blog on how peer to peer lending can gradually replace banking as banking reform unfolds.

Thanks for the blog:

Simon Dixon

Gaurav Sharma said...

Thank you Simon for your comments.

Yes, i agree, P2p is fast emerging as a new asset class. You have raised some very pertinent questions regarding Policy and regulatory issues in your blog.


Social Lending Network said...


Great article; an excellent synopsis of where p2p lending is right now.

BTW, I am happy for you to use my charts (the Lending Club and Prosper new loan originations), but in future I would like to get a link attributing them to me. Thanks.

Gaurav Sharma said...

Thanks Peter , Appreciate your comments and follow up. I have updated the link for next to the chart.

Must congratulate you for your wonderful site, cheers