Alternative Lending: Every Silver Lining Has a Cloud

The alternative lending industry went from an explosive growth, a goldmine for banks, to the cause of hot discussions over the viability of the very business models in the FinTech family. Some of the largest alternative lenders have been originating loans at such a pace that any bank can marvel at what technology can do in finances nowadays.

But the honeymoon seems to be coming to its end as an increasing number of authorities call to caution and reconsideration of the safety of the lending family in FinTech. Hazardous outcomes for the financial services industry have been previously mentioned but many, but didn’t have a substantial actionable outcome until this Friday when the FCA launched a call for input in crowdfunding rules.

The explosive growth of crowdfunding

According to the FCA, the crowdfunding market has grown rapidly from 2014. While an estimated £500 million was invested in regulated crowdfunding platforms over the course of 2013, over the course of 2015, the number reached ~£2.7 billion. There are now over 100 platforms in the market or seeking authorization to operate in the industry.

In particular, loan-based crowdfunding hit £2.4 billion in 2015 out of which ~£1.5 billion were in business loans and £909 million in consumer loans.

P2P lending draws attention of the authorities

A particularly concerning segment within alternative lending and crowdfunding has been drawn to P2P lending. The FCA has been attentively following the growth of P2P lending and plans to continue to monitor market risks related to companies’ infrastructures, systems and controls that may not be able to keep pace.

The estimations brought up in the call suggest that the potential of a collapse of one or more of the well-known platforms due to malpractice was seen as a high risk to growth by 57% of surveyed platforms, and a ‘cybersecurity breach’ was viewed by 51% of the surveyed platforms as a factor that could have a very detrimental effect on the sector.

The call for more stringent rules requires P2P platforms to assess the creditworthiness of borrowers including their ability to make repayments as they fall due. A month prior, Lord Turner, former chairman of the FCA, also raised concerns about P2P lenders’ ability to assess the risk to their lenders. As he commented, "The losses on peer-to-peer lending which will emerge within the next five to ten years will make the worst bankers look like absolute lending geniuses."

Another former FCA chairman (when it was the Financial Services Authority), Lord Adair Turner, has also warned that P2P lending and crowdfunding may pose grave systemic risks. As reported by the Financial Times, in February, Lord Adair Turner told a BBC interviewer that, over the next five to ten years, P2P loans could be the source of losses that make the worst bankers look like absolute lending geniuses.

Aside from authorities, industry professionals have also been taking notes on the potentially destructive effect of alternative lenders’ honeymoon period. As Justin Modray, Founder of Candid Money, commented, Peer-to-peer losses haven’t been a big problem to date, but then they’ve been operating over a fairly favorable period. If our economy struggles and borrowers start to feel the squeeze then we could see bad debts rise and peer-to-peer lenders lose money, no doubt causing some sleepless nights.

The bottom line is that it’s vital to fully appreciate the potential risks of peer-to-peer lending across varying economic cycles and I suspect many lenders don’t.

Not everyone sees P2P lenders as a threat

Regardless of a mainstreamed opinion that alternative lenders are of a threat to banks as they represent the pool of agile and highly innovative disruptors, there are professionals seeding a doubt over the idea. In particular, Deloitte has been reported to dismiss the threat of P2P lenders for banks, as the Telegraph reported at the end of May this year.

Indeed, the report of marketplace lending published in May by Deloitte suggests that by 2025, marketplace lenders (MPLs) might control up to 6% across key segments, including personal lending, SME business lending and the retail buy-to-let market in the UK, which, together, may represent approximately £600 billion of lending. However, if interest rates normalize and banks innovate, Deloitte estimates that marketplace lenders will face even lower market share – just 1% or £0.5 billion by 2025. Currently, estimations suggest that marketplace lenders have less than 1% market share in both consumer and SME lending.

As Neil Tomlinson, Head of UK banking at Deloitte, commented, Contrary to a number of commentators, we do not see MPLs as a major threat to banks in the mass market. Borrowers like the benefits of speed and convenience of MPLs, but those willing to pay a material premium to access loans quickly are in the minority.

Whilst banks are yet to replicate the benefits of the MPL model, we believe it is only a matter of time before they use their size and scale to overtake and sustainably underprice MPLs.