How Should Banks Respond?
P2P Lending: 2013
Is this an Opportunity or a Threat for Banks
Algorithms Linked to Social Networks
Lenders are probably not being altogether altruistic when they invest surplus funds across a P2P platform. The vast majority will, of course, be seeking to achieve a higher return than they could expect from a bank deposit. It is likely that all, or most, such lenders will appreciate that there is a significantly different risk profile in cutting out the middleman – i.e. a bank with deposit protection. Does the P2P lender: (i) have access to the risk adjusted return models which are standard in the banking industry, and (ii) have the ability to make informed investment decisions based upon these?
Funding Cost AdvantageIt is true for the vast majority of P2P lenders that they do not suffer the formal requirement to allocate shareholder capital against their lending as is imposed upon the banks through the Basel regulations. While P2P lenders might consider their opportunity cost of capital to be low, this might be a little misleading relative to the funding advantages (leverage and often zero interest deposits) enjoyed by the banks. Banks have learned over many decades how to price for increasing tenor and this is something that might be new to P2P lenders.
Portfolio DiversificationOne of the attractions of P2P lending appears to be that the transaction costs for lender are very low, meaning that it is quite easy to construct a portfolio of loan participations. The ability to diversify across several (or many) borrowers might be a comfort to lenders, but do they have the tools to assess whether they are achieving diversification benefits? How significant is the potential that their portfolios contain unrecognised concentration risks? In banking, there is a saying:
Investor ProtectionSeveral P2P platforms state that they are able to offer varying levels of investor protection, and if effective this could be a good mitigant for the above objections. For example: Landbay says it offers “protection funds”; Lending Works says it has “insurance”, and Madiston LendLoan Invest advertises its “compensation scheme”. The devil is always in the detail, and it is important to have a concept as to how these mitigants operate and who stands behind them
Attractions to Borrowers from P2PJust why are small businesses starting to use these platforms? Is it because the P2P process is quicker and less bureaucratic? Are they able to source cheaper, longer term funding from P2P compared to banks? Are P2P lenders financing borrowers who would be turned away by the banks? Or are the P2P platforms cherry-picking the banks’ best small business prospects? Can banks enjoy a better relationship with customers who source their financing from P2P lenders, enabling the banks to cross-sell non-credit products? The answers to these questions are likely to be central to the type of competitive response from the banks.
Some Key Challenges for P2P Business Models
Incentive ProblemsThis is essentially a broker model, wherein the provider of the P2P platform takes little or no financing risk. A root cause of asset bubble driven banking crises has often been a skewed reward structure wherein relationship managers have been incentivised to generate asset growth with little or no regard for the risks that they have piled onto their employers’ balance sheets.
If the P2P platforms have no risk of capital loss, could this mean that credit quality within the system might deteriorate and simply be passed around many P2P lenders rather than (as is currently the case) remaining in the hands of the originating bank?
Monitoring and the Identification of Early Warning Signals
However, it will be important to see how much attention the platforms will pay to advising their lenders of changes in the borrowers’ credit quality.
Without question, the earlier that problems are identified, the better the lender’s prospects of making a full recovery.
Problem LoansWho will take responsibility for negotiating restructurings when problems develop? This is a highly specialised, time-intensive and costly process. Loan workout and restructuring skills and cultures vary widely between existing lenders. How will P2P platforms perform?
Education of LendersBanks have invested huge sums in training their staff in credit analysis and associated topics. Will all (or even a reasonable percentage) of P2P lenders have the same or better understanding of these principles and techniques? And if the P2P platforms are to educate/ train potential lenders, is there not a significant conflict of interest?
There are, of course, myriad other issues for P2P platforms to manage, not least of which are potential fraud, anti-money laundering and KYC. However, within this article I have sought to identify some of the strategic questions and challenges with a view to providing bankers with a starting point for framing their strategic responses.
For assistance with developing your strategic response, training relevant staff or to provide feedback/comments on this article, please email me at: