Providing Perspective on Peer-to-Peer Lending
- by Dan Miller
Peer-to-peer (or marketplace) lending has recently gained significant media and investor attention with the initial public offerings of multibillion-dollar industry leaders Lending Club and OnDeck. Total issued loans for Lending Club climbed to $5 billion last June from less than $2.5 billion in June 2013. With the aim of riding the marketplace lending wave and disrupting antiquated financial markets around the world, hundreds of companies are now focused on lending via the online marketplace to borrowers in the consumer, education, real estate and startup verticals.
But how did online investment marketplaces get their start? What were the factors and conditions that led to the creation of the industry?
The Rise of Marketplace Lending
The financial crisis greatly contributed to the growing demand for alternatives to the traditional banking and lending system. After 2008, the government put strict regulations into place mandating that financial institutions hold more cash on their balance sheets. As a result, banks severely cut back on lending. In the wake of the Great Recession, two out of every five small and midsize businesses saw their credit lines threatened.
The Federal Reserve also lowered interest rates to historically low levels as part of a larger program to jump-start economic recovery, making it more attractive to borrow but more difficult to earn a high fixed rate of return for yield-hungry investors.
As the demand for capital grew in the years following the crisis and investors continued to seek higher rates of return on their investments, online lending was born, allowing lenders and borrowers to benefit.
The Role of the Internet
The other major factor that facilitated the rise of marketplace lending was the dissemination of the Internet and the willingness of individuals to transact online.
Though fewer than one in 10 customers of national banks would recommend their bank to a peer, willingness to bank online has skyrocketed. Upward of 61 percent of U.S. Internet users bank online—that’s more than 50 percent of U.S. adults. And this isn’t just using a desktop machine. Mobile and tablet usage for banking is growing rapidly too.
Through e-commerce, first with the sale of books on Amazon, which slowly turned into the sale of everything imaginable (and unimaginable), we’ve all gotten comfortable with making payments and banking online. Without consumer willingness to transact online, peer-to-peer lending would not exist.
Current Status of the Peer-to-Peer Lending Space
As traditional capital sources begin to lend more aggressively again, the alternative lending space continues to see enormous demand from borrowers who are attracted to the speed, convenience and efficiency of the online platform. According to the “Joint Small Business Credit Survey Report 2014,” conducted by four Federal Reserve banks, 18 percent of all business seeking funding applied for online loans.
Capitalizing on the speed and expanded network of the Internet, lending platforms bring investors, lenders and borrowers together with more efficiency than banks. Loans are syndicated electronically and can be sold with greater speed and scale than any investment handled on a one-off basis offline. Meanwhile, getting a loan through a traditional bank still takes an average of 25 hours of paperwork, not to mention the time you wait to actually receive your funds and the in-person meetings required.
Forbes recently published that the number of peer-to-peer lending platforms has increased 175 percent annually. Similar to how Amazon has changed the retail landscape, marketplace lending will drastically alter the way that lending and investment takes place. Instead of months of calls, meetings and applications, borrowers can secure funding with the click of a button.
In just over five years, the peer-to-peer marketplace lending industry has grown more than 9,000 percent, closing more than $9 billion in loans in 2014 alone. Furthermore, it’s expected that marketplace lending will be a $1 trillion industry by 2025. (See Foundation Capital’s white paper “A Trillion Dollar Market by the People, for the People” for a more detailed summary of the rise of the peer-to-peer lending industry.)
Though the marketplace lending industry is centered on removing the unnecessary middlemen that drive costs up and add inefficiencies, the best platforms will continue to have some sort of intermediation, but a data-driven one that vets loans in real-time and enables investors to make smart decisions.