Peer-to-peer lending (frequently referred to as ‘P2P’) is only one of many innovations that are rapidly changing today’s financial services industry. Yet it can be argued that P2P has achieved mainstream success more rapidly, and to a greater degree, than any other trends in recent memory. EY and the University of Cambridge recently released a report that claims it has ‘gone mainstream’ in Europe. According to the AFP, P2P is surging in the United States as well.
According to the EY and Cambridge report, between 2012 and 2014 P2P loans increased by over 280% in Europe, while in the United States the volume of loans on P2P platforms has surged an average of 84% each quarter since 2007, doling out nearly US$5.5 billion in loans in 2014. Its strong growth can be attributed to widespread frustration with the traditional banking system, where rapidly escalating compliance costs and risk aversion on the part of loan officers make it all but untenable for individuals and small businesses to receive lending services.
Hundreds of platforms are being built to meet this unprecedented demand as the industry’s early market entrants are already cashing in. Lending Club, one of the first P2P service providers (and the world’s largest), is a prime example. It was founded in 2006, during the industry’s earliest days, and successfully completed a stock offering in December 2014. The current market value of the company is nearly US$7.25 billion. Meanwhile its closest competitor, Prosper, achieved a valuation approaching US$2 billion during its latest funding round. By 2025, PWC projects that the industry will be worth as much as $150 billion.
In the industry’s early days, P2P platforms were created to support the issuance of consumer loans. However, today there is a platform to fund practically any form of debt. SoFi finances student loan debt. Need a mortgage? LendInvest will finance that.
Why is this market so attractive?
P2P is a model that’s enticing to borrowers and lenders – and also to investors. The model has less overhead than a traditional bank, since platforms don’t require traditional brick and mortar locations to sell their loans, and they are not burdened by regulations (such as capital requirements) that impact banks.
For borrowers, P2P loans can generally be obtained in less than a week, and the likelihood of a loan disbursement is quite high since P2P platforms have become quite skilled at understanding where lenders will likely be comfortable making a loan – and at what price. P2P algorithms are also sophisticated, and proving to be reliable at understanding the risk of a loan default.
In the early days of P2P – in the years immediately prior to the Global Financial Crisis of 2008 – P2P lenders were often retail investors who wished to diversify their investments outside of equity securities. Often, an investor would purchase portions of a loan – or portions of several different loans.
The P2P industry has now developed to the point where it is beginning to seize market share from banks, who currently generate as much as US$150 billion in annual revenues from consumer loans. Bank executives are not blind to the trend, though; in fact (and somewhat perversely) they are among the industry’s largest backers. In recent years banks and institutional investors have accounted for nearly 80% of all loan purchases on American P2P platforms, and they also rank among the industry’s most significant investors. The involvement of institutional lenders has led to a dynamic change in the market, as institutional investors have the scale to purchase loans wholesale, instead of being sold piecemeal and in fractions to retail investors.
While articles (such as this Euromoney piece) continue to talk of P2P becoming ‘mainstream’, the degree of involvement of institutional investors indicates that the P2P marketplace has been ‘mainstream’ in the developed world for quite some time.
Although developed markets are still offering enticing opportunities in the P2P ecosystem, entrepreneurs are already beginning to apply this successful model to frontier and emerging markets. There is a $1 trillion funding gap between the needs of frontier market SMEs and the amount of credit available, making these markets ripe for opportunity.
Early in 2015, Kenya-based Solvesting launched and is working to finance SME loans in Africa to retail and institutional investors, with amounts ranging between US$25 and US$100,000. Solvesting, however, is taking a different approach to P2P finance compared to other platforms – they purchase pre-existing loans from financial institutions and then offer them to their proprietary investor base.
In Japan, Crowdcredit is capitalizing on higher levels of growth in developing economies by offering emerging market debt to their local clients. The company just completed a US$1.7 million raise on a US$8.5 million valuation.
In South Africa, RainFin, which is 49% owned by Barclays Bank, has just expanded from offering consumer loans and now also provides services to SMEs. Although some might consider their market to carry higher levels of risk, the company reports a surprisingly low loan default rate of about 5%.
The global P2P lending market remains small when compared to the ‘conventional’ lending market, which runs into the trillions of dollars. However in developed markets, industry leaders like Prosper and Lending Club are already emerging. For entrepreneurs and others, emerging markets bring the potential of high upside – in terms of both enormous market demand and the potential to become an emergent industry leader.