Peer-to-peer lending

Peer-to-peer lending, sometimes abbreviated P2P lending, is the practice of lending money to individuals or businesses through online services that match lenders directly with borrowers. Since the peer-to-peer lending companies offering these services operate entirely online, they can run with lower overhead and provide the service more cheaply than traditional financial institutions. As a result, lenders often earn higher returns compared to savings and investment products offered by banks, while borrowers can borrow money at lower interest rates, even after the P2P lending company has taken a fee for providing the match-making platform and credit checking the borrower.

Also known as crowdlending, many peer-to-peer loans are unsecured personal loans, though some of the largest amounts are lent to businesses. Secured loans are sometimes offered by using luxury assets such as jewelry, watches, vintage cars, fine art, buildings, aircraft and other business assets as collateral. They are made to an individual, company or charity. Other forms of peer-to-peer lending include student loans, commercial and real estate loans, payday loans, as well as secured business loans, leasing and factoring.[1]

The interest rates can be set by lenders who compete for the lowest rate on the reverse auction model, or fixed by the intermediary company on the basis of an analysis of the borrower's credit.[2] The lender's investment in the loan is not normally protected by any government guarantee. On some services, lenders mitigate the risk of bad debt by choosing which borrowers to lend to, and mitigate total risk by diversifying their investments among different borrowers. Other models involve the P2P lending company maintaining a separate, ringfenced fund, such as RateSetter's Provision Fund, which pays lenders back in the event the borrower defaults. Bankruptcy of the peer-to-peer lending company that facilitated the loan may also put a lender's investment at risk, as has happened in 2015 in the case of TrustBuddy.

The lending intermediaries are for-profit businesses; they generate revenue by collecting a one-time fee on funded loans from borrowers and by assessing a loan servicing fee to investors (tax-disadvantaged in the UK vs charging borrowers) or borrowers (either a fixed amount annually or a percentage of the loan amount). Compared to stock markets, peer-to-peer lending tends to have both less volatility and less liquidity.[3]

Characteristics

Peer-to-peer lending does not fit cleanly into any of the three traditional types of financial institutions—deposit takers, investors, insurers[4]—and is sometimes categorized as an alternative financial service.[5]

Typical characteristics of peer-to-peer lending are:

Early peer-to-peer lending was also characterized by disintermediation and reliance on social networks but these features have started to disappear. While it is still true that the emergence of internet and e-commerce makes it possible to do away with traditional financial intermediaries and that people may be less likely to default to the members of their own social communities, the emergence of new intermediaries has proven to be time and cost saving. Extending crowdsourcing to unfamiliar lenders and borrowers opens up new opportunities.

Most peer-to-peer intermediaries provide the following services:

History

United Kingdom

The first company to offer peer-to-peer loans in the world was Zopa. Since its founding in February 2005, it has issued loans in the amount of 500 million GBP and is currently the largest UK peer-to-peer lender with over 500,000 customers.[6][7] In 2010 Funding Circle became the first significant peer-to-business lender launching in August 2010 and offering small businesses loans from investors via the platform.[8] Funding Circle is currently the second largest lender, having lent 170 million GBP as of November 2013.[9]

In 2011, Quakle, a UK peer-to-peer lender founded in 2010, closed down with a near 100% default rate after attempting to measure a borrower's creditworthiness according to a group score, similar to the feedback scores on eBay; the model failed to encourage repayment.[6][10]

By June 2012, the top three peer-to-peer companies in the UK - RateSetter, Zopa and FundingCircle - had issued over £250 million of loans.[11] In 2014 alone, they issued over £700 million.[12]

In 2012 the UK government invested £20 million into British businesses via peer to peer lenders. A second investment of £40 million was announced in 2014.[13] The intention was to bypass the high street banks, which were reluctant to lend to smaller companies. However this action was criticised for creating unfair competition in the UK, by concentrating financial support in the largest platforms.[14]

Many more peer-to-peer companies have also set up in the UK. At one stage there were over 100 individual platforms applying for FCA authorisation, although many have now withdrawn their applications.[15]

Since April 2014 the peer-to-peer lending industry has been regulated by the Financial Conduct Authority.[16] Peer-to-peer investments do not qualify for protection from the Financial Services Compensation Scheme (FSCS), which provides security up to £75,000 per bank, for each saver,[17] but regulations mandate the companies to implement arrangements to ensure the servicing of the loans even if the platform goes bust.[18]

In 2015, UK peer-to-peer lenders collectively lent over £3bn to consumers and businesses.[19]

United States

The modern peer-to-peer lending industry in US started in February 2006 with the launch of Prosper, followed by Lending Club and other lending platforms soon thereafter.[20] Both Prosper and Lending Club are located in San Francisco, California.[21] Early peer-to-peer platforms had few restrictions on borrower eligibility, which resulted in adverse selection problems and high borrower default rates. In addition, some investors viewed the lack of liquidity for these loans, most of which have a minimum three-year term, as undesirable.[5]

In 2008, the Securities and Exchange Commission (SEC) required that peer-to-peer companies register their offerings as securities, pursuant to the Securities Act of 1933.[20][22] The registration process was an arduous one; Prosper and Lending Club had to temporarily suspend offering new loans,[23][24][25][26] while others, such as the U.K.-based Zopa Ltd., exited the U.S. market entirely.[23] Both Lending Club and Prosper gained approval from the SEC to offer investors notes backed by payments received on the loans. Prosper amended its filing to allow banks to sell previously funded loans on the Prosper platform.[5] Both Lending Club and Prosper formed partnerships with FOLIO Investing to create a secondary market for their notes, providing liquidity to investors.[27] Lending Club had a voluntary registration at this time, whereas Prosper had mandatory registration for all members.[28]

This addressed the liquidity problem and, in contrast to traditional securitization markets, resulted in making the loan requests of peer-to-peer companies more transparent for the lenders and secondary buyers who can access the detailed information concerning each individual loan (without knowing the actual identities of borrowers) before deciding which loans to fund.[23] The peer-to-peer companies are also required to detail their offerings in a regularly updated prospectus. The SEC makes the reports available to the public via their EDGAR (Electronic Data-Gathering, Analysis, and Retrieval) system.

More people turned to peer-to-peer companies for lending and borrowing following the financial crisis of late 2000-s because banks refused to increase their loan portfolios. On the other hand, the peer-to-peer market also faced increased investor scrutiny because borrowers' defaults became more frequent and investors were unwilling to take on unnecessary risk.[29]

As of June 2012, Lending Club is the largest peer-to-peer lender in US based upon issued loan volume and revenue, followed by Prosper.[20][21][30] Lending Club is currently also the world's largest peer-to-peer lending platform.[31] The two largest companies have collectively serviced over 180,000 loans with $2 billion in total:[11][20][21] as of March 22, 2012, Lending Club has issued 117,412 loans for $1,512,560,075[32] while Prosper Marketplace has issued 63,023 loans for $433,570,651.[33] With greater than 100% year over year growth, peer-to-peer lending is one of the fastest growing investments.[20] The interest rates range from 5.6%-35.8%, depending on the loan term and borrower rating.[34] The default rates vary from about 1.5% to 10% for the more risky borrowers.[21] Executives from traditional financial institutions are joining the peer-to-peer companies as board members, lenders and investors,[11][35] indicating that the new financing model is establishing itself in the mainstream.[22]

China

A colloquial term for P2P lending in China is grey market, not to be confused with grey markets for goods or an underground economy. Offline peer-to-peer lending between family and friends is a popular practice and has been around in the country for centuries. In recent years a very large number of micro loan companies have emerged to serve the 40 million SMEs, many of which receive inadequate financing from state-owned banks, creating an entire industry that runs alongside big banks.

As the Internet and ecommerce took off in the country in the 2000s, many P2P lenders sprung into existence with various target customers and business models. The most prominent among them are CreditEase, Lufax, Tuandai, China Rapid Finance and DianRong (former SinoLending).[36][37] CreditEase runs a huge offline network with branches in major Chinese cities, and the latter has links to Lending Club in the U.S. and concentrates on the online market.[38][39]

The first P2PL in Hong Kong is WeLab Holdings, which has backing from American venture capital firm Sequoia Capital and Li Ka-Shing's TOM Group.[40]

Ezubao, a website launched by Yucheng Group in July 2014 purporting to offer P2P services, was shut down in February 2016 by authorities who described it as a Ponzi scheme.[41] As 900,000 customers had invested 50 billion renminbi in Ezubao, its closure might undermine confidence in P2P in China.[42]

Australia

In 2012 Australia's first peer to peer lending platform, SocietyOne, was launched.[43]

New Zealand

In New Zealand, peer-to-peer lending became practicable on April 1, 2014, when the relevant provisions of the Financial Markets Conduct Act 2013 came into force. The Act enables peer-to-peer lending services to be licensed.

The Financial Markets Authority issued the first peer-to-peer lending service licence on July 8, 2014, to Harmoney.[44] Harmoney officially launched its service on October 10, 2014.[45]

India

In India, peer-to-peer lending is currently unregulated. Reserve Bank of India, India's Central Bank, currently has no plans to regulate P2P lending as the current volume of P2P lending in India is low. Most P2P platforms are in nascent stages.

Several peer-to-peer lending services initiated operation and loan origination during 2012.

Sweden

Peer-to-peer-lending in Sweden is regulated by Finansinspektionen.[46] Launched in 2007, the company Trustbuddy AB was first out on the Swedish market for peer-to-peer-lending, providing a platform for high risk personal loans between 500SEK and 10,000SEK. Trustbuddy filed for bankruptcy by October 2015, a new board cited abuses by outgoing leadership.

Israel

Several peer-to-peer lending services initiated operation and loan origination during 2014, Following the economic uprising of 2011,[47] and public opinion regarding these platforms is positive. The maximum interest rate in Israeli P2P Arenas is limited by the "Extra-Banking Lending Regulations".[48]

Canada

Although the emergence of peer-to-peer lenders in Canada was slower than in many other countries, a number of startups had emerged by the first quarter of 2015. Grouplend, based in Vancouver, is the country's largest peer-to-peer lending platform, having processed $65 million in loan applications by May 2015.[49] The technological innovation of these alternative players has become a cause for concern for the country's five major banks.[50]

Brazil

In Brazil, the lack of credit scenario and the rise of interest rates began to make room for this loan market by internet.[51]

To operate in the country, these companies need to comply with certain rules of the domestic financial market. While in most countries the peer-to-peer landing operations are carried out without the intermediation of a financial institution, in Brazil that is not possible. To stick to the rules, the platforms need to act as a correspondent bank, helping to structure a loan that is accomplished, in fact, by the partner bank.[51]

Legal regulation

In many countries, soliciting investments from the general public is considered illegal. Crowd sourcing arrangements in which people are asked to contribute money in exchange for potential profits based on the work of others are considered to be securities.

Dealing with financial securities is connected to the problem about ownership: in case of person-to-person loans, the problem of who owns the loans (notes) and how that ownership is transferred between the originator of the loan (the person-to-person lending company) and the individual lender(s).[24][25] This question arises especially when a peer-to-peer lending company does not merely connect lenders and borrowers but also borrows money from users and then lends it out again. Such activity is interpreted as a sale of securities, and a broker-dealer license and the registration of the person-to-person investment contract is required for the process to be legal. The license and registration can be obtained at a securities regulatory agency such as the U.S. Securities and Exchange Commission (SEC) in the U.S., the Ontario Securities Commission in Ontario, Canada, the Autorité des marchés financiers in France and Quebec, Canada, or the Financial Services Authority in the UK.

Securities offered by the U.S. peer-to-peer lenders are registered with and regulated by the SEC. A recent report by the U.S. Government Accountability Office explored the potential for additional regulatory oversight by Consumer Financial Protection Bureau or the Federal Deposit Insurance Corporation, though neither organization has proposed direct oversight of peer-to-peer lending at this time.[52]

In the UK, the emergence of multiple competing lending companies and problems with subprime loans has resulted in calls for additional legislative measures that institute minimum capital standards and checks on risk controls to preclude lending to riskier borrowers, using unscrupulous lenders or misleading consumers about lending terms.[53]

Advantages and criticism

Interest rates

One of the main advantages of person-to-person lending for borrowers can sometimes be better rates than traditional bank rates can offer.[54] The advantages for lenders can be higher returns than obtainable from a savings account or other investments, but subject to risk of loss, unlike a savings account.[55] Interest rates and the methodology for calculating those rates varies among peer-to-peer lending platforms. The interest rates may also have a lower volatility than other investment types.[56]

Socially-conscious investment

For investors interested in socially conscious investing, peer-to-peer lending offers the possibility of supporting the attempts of individuals to break free from high-rate debt, assist persons engaged in occupations or activities that are deemed moral and positive to the community, and avoid investment in persons employed in industries deemed immoral or detrimental to community.[57]

Credit risk

Peer-to-peer lending also attracts borrowers who, because of their credit status or the lack thereof, are unqualified for traditional bank loans. Because past behavior is frequently indicative of future performance and low credit scores correlate with high likelihood of default, peer-to-peer intermediaries have started to decline a large number of applicants and charge higher interest rates to riskier borrowers that are approved.[29] Some broker companies are also instituting funds into which each borrower makes a contribution and from which lenders are recompensed if a borrower is unable to pay back the loan.[6]

It seemed initially that one of the appealing characteristics of peer-to-peer lending for investors was low default rates, e.g. Prosper's default rate was quoted to be only at about 2.7 percent in 2007.[55]

The actual default rates for the loans originated by Prosper in 2007 were in fact higher than projected. Prosper's aggregate return (across all credit grades and as measured by LendStats.com, based upon actual Prosper marketplace data) for the 2007 vintage was (6.44)%, for the 2008 vintage (2.44)%, and for the 2009 vintage 8.10%. Independent projections for the 2010 vintage are of an aggregate return of 9.87.[58] During the period from 2006 through October 2008 (referred to as 'Prosper 1.0'), Prosper issued 28,936 loans, all of which have since matured. 18,480 of the loans fully paid off and 10,456 loans defaulted, a default rate of 36.1%. $46,671,123 of the $178,560,222 loaned out during this period was written off by investors, a loss rate of 26.1%.[59]

Since inception, Lending Club’s default rate ranges from 1.4% for top-rated three-year loans to 9.8% for the riskiest loans.[21]

The UK peer-to-peer lenders quote the ratio of bad loans at 0.84% for Zopa of the £200m during its first seven years of lending history. As of November 2013, Funding Circle’s current bad debt level was 1.5%, with an average 5.8% return after all bad debt and fees. This is comparable to the 3-5% ratio of mainstream banks and the result of modern credit models and efficient risk management technologies used by P2P companies.[10]

At the other end of the range are places such as Bondora that do lending to less credit-worthy customers, with default rates varying up to as high as 70+% for loans made to Slovak borrowers on that platform, well above those of its original Estonian market.

Government protection

Because, unlike depositing money in banks, peer-to-peer lenders can choose themselves whether to lend their money to safer borrowers with lower interest rates or to riskier borrowers with higher returns, in the US peer-to-peer lending is treated legally as investment and the repayment in case of borrower defaulting is not guaranteed by the federal government (U.S. Federal Deposit Insurance Corporation) the way bank deposits are.[60]

A class action lawsuit, Hellum v. Prosper Marketplace, Inc. was held in Superior Court of California on behalf of all investors who purchased a note on the Prosper platform between January 1, 2006 and October 14, 2008. The plaintiffs alleged that Prosper offered and sold unqualified and unregistered securities, in violation of California and federal securities laws during that period. Plaintiffs further allege that Prosper acted as an unlicensed broker/dealer in California. The Plaintiffs were seeking rescission of the loan notes, rescissory damages, damages, and attorneys' fees and expenses.[61] On July 19, 2013 the class action lawsuit was settled. Under the settlement terms Prosper will pay $10 million to the class action members.[62]

See also

References

  1. ↑ Moenninghoff, S., Wieandt, A. "The Future of Peer-to-Peer Finance". Retrieved May 20, 2014.
  2. ↑ Lepro, Sara (December 20, 2010). "Prosper Ditches Auction Pricing for Model Like P-to-P Rival's". American Banker. Retrieved July 31, 2012.
  3. ↑ J. D. Roth Taking a Peek at Peer-to-Peer Lending Time November 15, 2012; Accessed March 22, 2013.
  4. ↑ Robert E. Wright; Vincenzo Quadrini. Chapter 2 Section 5: Financial Intermediaries (PDF). Retrieved August 5, 2012.
  5. 1 2 3 Bradley, Christine; Burhouse, Susan; Gratton, Heather; Miller, Rae-Ann (2009). "Alternative Financial Services: A Primer". FDIC Quarterly 3 (Q1) (Federal Deposit Insurance Corporation). Retrieved July 30, 2012
  6. 1 2 3 Dunn, Sam (December 7, 2011). "Fears grow over safety of 'peer-to-peer' savings after lender Quakle goes bust". Daily Mail. Retrieved August 2, 2012.
  7. ↑ Emma Simon Can you trust 'peer to peer' lending? The Daily Telegraph (London), March 3, 2013; Accessed March 22, 2013
  8. ↑ Patrick Collinson (August 28, 2010). "Peer-to-peer lending and saving: Making everyone happy". The Guardian.
  9. ↑ Kiki Loizou (October 20, 2013). "Start-ups to the power of three". The Sunday Times.
  10. 1 2 Moulds, Josephine (June 9, 2012). "Are peer-to-peer lenders the future of banking?". The Guardian. Retrieved July 25, 2012.
  11. 1 2 3 Goff, Sharlene (June 13, 2012). "Peer-to-peer lending: Model takes off worldwide". Financial Times. Retrieved August 2, 2012.
  12. ↑ "2015 UK Volume Predictions". AltFi. December 23, 2014. Retrieved August 19, 2015.
  13. ↑ "New £40 million investment by British Business Bank to support £450 million of lending to smaller businesses". Gov.uk. February 25, 2015. Retrieved August 19, 2015.
  14. ↑ "Government interference risks distorting UK P2P market, say lenders". Financial Times. October 26, 2014. Retrieved August 19, 2015.
  15. ↑ "26% of P2P lenders withdraw FCA applications for authorisation". Bovill. Retrieved March 24, 2016.
  16. ↑ Jonathan Moules (December 7, 2012). "Government boost for peer-to-peer lending". Financial Times.
  17. ↑ "New deposit protection limit coming on 1 January |FSCS". www.fscs.org.uk. Retrieved March 24, 2016.
  18. ↑ "Peer-to-peer: FCA confirms new rules". www.moneysupermarket.com. Retrieved March 24, 2016.
  19. ↑ "Pushing boundaries: the 2015 UK alternative finance industry report | Nesta". www.nesta.org.uk. Retrieved March 24, 2016.
  20. 1 2 3 4 5 Renton, Peter (May 29, 2012). "Peer To peer lending crosses $1 billion in loans issued". Techcrunch. Retrieved July 25, 2012.
  21. 1 2 3 4 5 Barth, Chris (June 6, 2012). "Looking for 10% yields? Go online for peer to peer lending". Forbes. Retrieved July 25, 2012.
  22. 1 2 Alloway, Tracy; Moore, Elaine (April 23, 2012). "Mack moves to cutting edge of P2P lending". Financial Times. Retrieved July 20, 2012.
  23. 1 2 3 Jane J. Kim (April 28, 2009). "Peer-To-Peer Lender Relaunched". The Wall Street Journal. Retrieved July 25, 2012.
  24. 1 2 Hendrickson, Mark (April 8, 2008). "Peer Lending Club Puts Hold on Lending Activity While It Sorts Out Some Legal Issues". Techcrunch. Retrieved August 2, 2012.
  25. 1 2 "Lending Club Shuts Down (Temporarily?)". Peer-Lend. Retrieved April 8, 2008.
  26. ↑ "Quiet Period". Lending Club. Retrieved April 8, 2008.
  27. ↑ Jonnelle Marte (September 26, 2010). "Credit Crunch Gives 'Microlending' a Boost". The Wall Street Journal. Retrieved August 23, 2012.
  28. ↑ David Bogoslaw (April 6, 2009). "Peer-to-Peer Lending: Problems and Promise". BusinessWeek. Retrieved June 27, 2013.
  29. 1 2 Kennard, Matt; Bond, Shannon (November 24, 2011). "Interest soars in US peer-to-peer lending". Financial Times. Retrieved July 20, 2012.
  30. ↑ Peter Renton Lending Club Issues $120 Million in New Loans in February LendAcademy, February 28, 2013; Accessed March 18, 2013
  31. ↑ Schumpeter Peer review The Economist January 5, 2013; Accessed March 22, 2013.
  32. ↑ "Loan Performance Statistics". Lending Club. Retrieved August 13, 2012.
  33. ↑ "Prosper: Marketplace Performance". =Prosper Marketplace, Inc. Retrieved August 13, 2012.
  34. ↑ Steinisch, Monica (June 2012). "Peer-to-peer lending survey". Consumer Action. Retrieved July 23, 2012.
  35. ↑ Taylor, Colleen (June 6, 2012). "Lending Club Lands $17.5 Million from Kleiner Perkins and Morgan Stanley Chairman John Mack". Tech Crunch. Retrieved June 8, 2012.
  36. ↑ Jason Jones. "The Most Important Chinese P2P Lending Companies". Lend Academy.
  37. ↑ Yangjie She. "China: The Different Categories of Peer to Peer Lending Platforms". Crowdfund Insider.
  38. ↑ "China Shadow Bankers Go Online as Peer-to-Peer Sites Boom". Bloomberg News. July 23, 2012.
  39. ↑ Simon Rabinovitch (February 7, 2011). "Peer-to-peer lending takes root in China". Financial Times. Retrieved May 28, 2013.
  40. ↑ Michelle Yuan. "Hong Kong’s First Peer-to-Peer Lender Raises Funds of its Own". WSJ.
  41. ↑ Gough, Neil (February 2, 2016). "Online Lender Ezubao Took $7.6 Billion in Ponzi Scheme, China Says". The New York Times. Retrieved February 2, 2016.
  42. ↑ Shen, Samuel; Ruwitch, John. "China police arrest 21 over $7.6 bln online financial scam". Reuters. Retrieved February 2, 2016.
  43. ↑ "SocietyOne takes on big banks with peer-to-peer online loans". ARN Net. Retrieved June 29, 2015.
  44. ↑ "FMA issues New Zealand’s first licence for peer-to-peer lending services".
  45. ↑ "Harmoney launches with $100m to lend - Personal Finance".
  46. ↑ "FI tar kontroll över ny lånetrend". SvD.se. Retrieved February 24, 2015.
  47. ↑ he:המחאה החברתית בישראל 2011
  48. ↑ http://www.nevo.co.il/law_html/Law01/047_031.htm
  49. ↑ Barbara Shecter (May 22, 2015). "Marketplace lenders step out of the shadows in Canada — should we be worried?". Financial Post.
  50. ↑ "Peer-to-peer lending makes inroads in Canada". CTVNews.
  51. 1 2 "Mercado de empréstimo online começa a atrair investidores no Brasil". O Estado de S Paulo. O Estado de S Paulo. Retrieved May 26, 2015.
  52. ↑ "PERSON-TO-PERSON LENDING: New Regulatory Challenges Could Emerge as the Industry Grows (Report to Congressional Committees)" (PDF). United States Government Accountability Office. July 2011. Retrieved August 23, 2012.
  53. ↑ Sean Farrell (September 20, 2010). "Zopa calls on Government and FSA to regulate social lending sector". The Daily Telegraph. Retrieved July 25, 2012.
  54. ↑ Social Lending Network, accessed September 21, 2010
  55. 1 2 Person-to-person lending online gathers steam Associated Press, November 27, 2007.
  56. ↑ JD Roth (November 15, 2012). "Taking a Peek at Peer-to-Peer Lending". Time Magazine. Retrieved June 27, 2013.
  57. ↑ "Christian Peer-to-Peer Lending - Faith Saves". Faith Saves. Retrieved February 24, 2015.
  58. ↑ http://www.lendstats.com/ Prosper.com - Loan Performance Summary - Independent Loan Analytics courtesy of LendStats.com
  59. ↑ Social Lending Network, accessed August. 13, 2012
  60. ↑ Gompertz, Simon (June 8, 2012). "Peer-to-peer lending via the internet hits £250m". BBC News. Retrieved August 3, 2012.
  61. ↑ Superior Court of California, County of San Francisco, Docket: [Case Number: CGC-09-491736 http://webaccess.sftc.org/Scripts/Magic94/mgrqispi94.dll?APPNAME=IJS&PRGNAME=ROA22&ARGUMENTS=-ACGC09491736](retrieved February 1, 2011)
  62. ↑ http://www.p2p-banking.com/group-news/services/prosper-prosper-settles-class-action-lawsuit-pays-10m-us/, retrieved July 19, 2013
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