Marketplace lending, a constant headline of major financial journals for the last few years, is a new form of credit intermediation. The term broadly refers to debt financing models whereby borrowers and lenders are pooled and matched together through an online platform.
Conceptually, the beauty of the matching nature of marketplace and peer-to-peer lending is that it is a perfect solution for matching supply and demand of capital and risks. Finding the right risk profile for the investor and matching maturity, currency, and tenor would eliminate a lot of regulatory hassle and burdens.
However, for this conceptual framework to function, a lot of questions need to be answered. Let us examine a few.
Marketplace lending can be attractive for institutional investors for several reasons: matching their risk profile with the investment they are looking for, diversification, and return. In addition, they are engaging a business model based on a wider shift in consumer behaviour and expectations (digitisation, convenience, immediacy).
Despite these obvious advantages, institutional investors have not yet fully embraced marketplace lending. Why?
In principle, investing through marketplace lenders should require fewer resources to assess loans. Still, many platforms do not disclose comprehensive information about their credit assessment processes.
Many investors do not “bother” to look at investment opportunities below a certain size due to internal resource constraints and consolidation issues. The size of the market in peer-to-peer lending is not large enough to be on the radar screen of investors yet; they still want to see proof-of-concept and potential to scale up.
Uncertainties regarding future regulatory developments are one of the key obstacles. Based on the research carried out by Cambridge Centre of Alternative Finance, there is currently a lack of consensus among market participants regarding the existing and proposed level of regulation. According to the study, 38 per cent of European lending platforms consider existing national regulation as “adequate and appropriate”, while 28 per cent perceive it as “excessive and too strict”.
Many investors still have concerns about the loan origination and due diligence processes. The relevance of the new sources of data is unproven, and so are the risk pricing models. This comes as some market players reported increases in delinquent loans. The business model of marketplace lenders is largely based on minimizing costs; any future improvements in origination and screening procedures are likely to increase costs, which further calls into question the viability of the business model.
At present, the secondary market for marketplace loans is in its infancy. Consequently, potential liquidity risks are relatively high and the exit options for investors are limited.
Contrary to traditional lending models, marketplace lenders may not have sufficient direct incentives to identify early warning signals and ensure the recovery of the defaulted loan obligations. Some platforms claim they transfer loans to collection agencies, but investors have no direct control over this process. Investors often find it difficult to assess the alignment of interests with these agencies, particularly how they are paid and incentivised to ensure the recovery from their perspective.
Comparability is crucial. The development of a common assessment framework is a vital step in establishing greater investor confidence in the marketplace lending space. At present, the lack of a uniform set of standards places severe obstacles for investors willing to invest across multiple marketplace lenders. The data structure, terminology, and methodologies differ greatly from platform to platform. This creates market friction, as investors incur high costs (both in terms of time and resources) to be able to accurately evaluate complex cross-platform data. For many, these costs are prohibitively high.
Overall, the concern about platforms not being around throughout the full cycle relates not only to the limited experience and track record of these new players, but also to the underwriting techniques that lie at the heart of their business model. It is likely that marketplace lenders will be able to adequately recalibrate their models to reflect changing economic conditions; however, rising interest rates will undoubtedly translate into rising costs, thus reducing returns and competitiveness. And unlike traditional bank lending formats, marketplace lenders cannot rely on deeper relationships with their borrowers in adverse circumstances due to the digital nature of their business.
Yes, it is realistic to assume that peer-to-peer and marketplace lenders will be considered at a larger scale.
It might, however, take a longer time. As discussed above, the market still needs to develop these three most important aspects:
I believe the business model and concept can have serious upside potential if these issues are addressed properly due the superior ability to match demand and supply of capital.
- G. Kindert