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July 3, 2017

P2P lenders such as Lending Club and Prosper started out as niche businesses to enable investors with surplus funds to invest directly into loans to borrowers that are unable to get funding from traditional banks. The lure for investors is to obtain higher yields than available, through traditional investments like bonds and certificates of deposits. And borrowers obtain loans despite having low credit scores.

The P2P lending industry quickly grew into a multi-billion dollar industry measured by loans outstanding. As the industry grew in size, it was found that sourcing funds in bulk from institutional investors was more efficient than trying to match individual investors with individual borrowers. Large players such as Lending Club and Prosper transformed their businesses from P2P lending to marketplace lending.

Banks Fund Marketplace Loans

The new avatar of alternative lenders as marketplaces was attractive to banks; they could enroll themselves as investors in these platforms and access a pool of borrowers, whom they had traditionally not catered to. By taking aid from sophisticated credit scoring models pioneered by alternative lenders, banks were able to rapidly approve loans and lend through these platforms. Indeed, this model has become so successful that banks now account for more than 25% of the source of funds lent through the Lending Club platform.

Banks Become Marketplaces

As technologies such as Big Data analytics, which enabled alternative lenders to quickly approve loans, became mainstream, banks started making significant investments of their own to achieve parity in their ability to mine external (through social profiling, smartphone analytics, and so on) and internal data sources (such as transaction records, credit history). They also started undertaking digital transformation initiatives to significantly improve their service capabilities, reduce turnaround times, and improve customer experiences. They further introduced paperless lending and instant decision-making.

Having upped their game thus, banks such as like CommerzBank and Sterling Bank are now entering the marketplace lending business by launching their alternative lending platforms.

In an earlier point of view, we had anticipated the trend of increasing collaboration between banks and alternative lenders. We suggested that banks could utilize them for performing distribution and indirect lending, purchasing loan portfolios, and managing venture funding

However, recent stumbles by alternative lenders have created a window of opportunity for banks to pose direct competition rather than merely collaborate with them. Also, technology investments have enabled banks to compete with alternative lenders. A significant development is that technology vendors (for instance, Misys Fusionbanking Crowdlending) have started launching digital platforms whereby banks can offer P2P lending to customers. Such platforms aim to help banks provide additional investment avenues to their customers, and earn higher yields on their funds.

With their superior financial strength, advanced risk management capabilities, access to customer base at both ends (investors and borrowers), banks may well be able to achieve significant market share in this industry.

Regulations in P2P Lending

Central banks and regulatory bodies have been collecting information on the number and ticket-size of loans in the P2P lending area, alongside the type of customer complaints for the past year. More regulations are expected in the coming years, as P2P lending is increasing at a fast pace. Banks need to ensure that borrowers are protected, as well as regulate such P2P loans lent on their platform, based on existing traditional regulation policies. Thus, when the new regulations kick in, they wont be caught off-guard.

Notes of Caution

Banks must stay cautious that this new line of business does not cannibalize their deposit franchise, and curbs their ability to generate deposits, which are the primary source of funds for their lending businesses. P2P lending involves higher risk for customers who choose to be lenders. Banks must judiciously target this business only toward those customers who have funds in large surplus, and not particularly toward customers who may not be able to absorb losses arising out of unreturned sums of money. Banks should also permit only a portion of the customers deposit towards P2P lending, which will safeguard the banks interests as well.

Further, they need to address other risks attached to being marketplace lenders. High net worth customers may be able to differentiate clearly between low risk bank deposits and high risk (but high yielding) marketplace loans. Unsophisticated investors, on the other hand, may not be able to do so, and may associate defaults on loans with the banks failure to honor deposits. The bank can attempt to educate customers prior to participating in P2P lending, through videos and other material, in order to convey associated risks.

Vivek Iyer is a Functional Consultant with the Banking and Financial Services (BFS) business unit at Tata Consultancy Services (TCS). He has around 13 years of experience with expertise in the commercial and consumer lending space, and focuses on industry advisory, thought leadership and solution conceptualization activities. Prior to joining TCS, Vivek worked with leading multinational banks in commercial lending, and in product development for Oracle's Flexcube suite of financial solutions. Vivek holds an MBA in Finance and Corporate Strategy from the Indian Institute of Management, Indore, India, and a bachelor’s degree in computer engineering from the University of Pune, India.


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