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July 28, 2016

Marketplace lending or peer-to-peer (P2P) lending has gathered notable traction across the globe, especially with a whole new breed of Fintech startups taking form. With the lending process at banks becoming stricter post the implementation of the (CPA), consumers have started approaching P2P lenders as an alternative financial credit option. So what makes P2P lenders different? A simple application process, quick funding decisions, and instant credit availability and you have a winner!

In 2014, US P2P lenders issued approximately $5.5 billion of loans; market reports indicate that this industry will grow to more than $150 billion by 2025. Lending Club, OnDeck, and Kabbage are some P2P lenders that have taken the US mortgage market by storm. Chinas P2P lending sector exploded in 2015, with the total volume estimated at $33.2 billion. In comparison to traditional banks, P2P lenders operate at much lower costs, are more nimble, and can innovate faster.

So, is all rosy in the P2P lending space?

Not really. P2P lending may be a path-breaking disruption for the global financial services industry, but it comes with its own baggage. Rapid, unchecked growth of this parallel industry has resulted in several instances of fraud lately. Ezubao, an online lending scheme in China duped investors of over $7.6 billion in the guise of non-existent securities. A classic example of a Ponzi scheme, this incident has brought to the fore the perils of quick and easy credit access.

We are not talking only about bilking investors here. This unregulated space has seen instances of money laundering and suspected terror financing as well. Recently, Prosper Marketplace Inc. found itself in an uncomfortable spot. Federal officers discovered that the online lender extended a hefty loan to the San Bernardino shooter just days before the December 2015 rampage. Such incidents have sent regulators across the globe into a tizzy. They have begun to draft guidelines to restore customer confidence and ensure market stability with regard to P2P lending.

Drawing from the Ezubao experience, the China Banking Regulatory Commission (CBRC) has laid down certain rules for online marketplace lenders. Online lenders are now required to publicly disclose aggregate loan information and performance. All peer-to-peer lenders need to register with local financial authorities to improve transparency. This will compel online lenders to act only as information intermediaries, and not as credit intermediaries. P2P lenders will not be allowed to leverage outside funding, something that is typical in the US and other countries with established direct lending industries.

The Securities and Exchange Board of India (SEBI), in its consultation paper on crowdfunding, discusses the importance of a regulated environment keeping the interests of all stakeholders in mind. In a developing economy like India, providing alternate credit sources to small businesses is important for their survival, as well as for the growth of the economy. On the other hand, uninhibited participation from can be quite dangerous.

Will P2P lenders survive in the longer run?

Despite Lending Clubs huge success close to $16 billion have been originated through its platform in 2015 its shares have dropped by more than 50% since December 10, 2015. Securitization of P2P loans, which is considered a win-win for both investors and borrowers so far, can turn foul in the absence of proper scrutiny and oversight. And with the , one would wonder if we are again heading in the same direction a P2P lending bubble waiting to burst.

Recent developments in the P2P lending space, along with regulatory actions proposed in different geographies, may restrict the participation of investors, which can challenge the growth of the P2P ecosystem. The question is, do we want P2P lending to grow into something bigger, maybe as big as traditional banking? If yes, then quite a few issues will need to be ironed out. Regulating this somewhat unregulated space is of prime concern. Only time will tell how regulations will shape up this new paradigm, but one thing is for sure P2P lenders must start redefining their operating models in anticipation of what lies ahead.

Suvradeep Mukherjee is a Consultant with the Lending practice of the Banking and Financial Services (BFS) unit at Tata Consultancy Services (TCS). His expertise lies in retail and commercial banking, especially alternate lending. Mukherjee holds a Post Graduate Diploma in Management (Finance) from the Xavier Institute of Management and Entrepreneurship, Bengaluru, India.


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