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When the concept of “peer-to-peer” lending popped up a decade ago, libertarians and leftwing idealists alike cheered. For the idea of using the internet to match borrowers who needed cash with lenders seemed to epitomise the sharing economy.

What made P2P sound doubly exciting — at least in the aftermath of the 2008 crisis — was that these platforms also appeared to thumb a nose at the banks. Or, to use the technical term, P2P threatened to “disintermediate” mainstream finance, in a democratic way.

But that utopian ideal is starting to be turned upside down. True, if you look at the profile of who is providing loans on America’s biggest P2P platforms today, such as Lending Club and Prosper Marketplace, you will still see wealthy “mom and pop” investors, attracted by the hope of good returns in a low interest rate world. Since 2009 loans on the big P2P platforms have generated yields of between 5 and 9 per cent.

But those plucky individuals are in a minority — and a shrinking one. These days, four-fifths of the finance on P2P platforms comes from institutions, such as hedge funds, or arms of the established banks.

Indeed, hedge funds and banks are now moving into this sector with such a vengeance that they are not only repackaging those P2P loans into new instruments, via securitisation; they are lending via these platforms too.

Earlier this year, for example, Citigroup agreed a $150m tie-up with Lending Club, to finance loans. Citizens Bank has bought $200m of loans from SoFi, a big student loan-focused marketplace lender, and committed to buy $300m more. Instead of thumbing their nose at banks, in other words, P2P lenders are co-opting them, if not being co-opted too. In financial terms, this is like Uber quietly cutting deals with established taxi companies.

Does this matter? The answer to that question depends on what you think the main priority for modern finance should be. If you think that the system needs to provide more credit to the economy, in order to to boost growth, this quiet transformation should seem welcome.

After all, the arrival of banks and hedge funds will enable the sector to expand more rapidly. And borrower demand seems sky high; PwC predicts that P2P lending will swell to $150bn by 2025, from $5.5bn in 2014.

But if you think that the main goal of finance should be to create safe, clear rules for capital flows, then this pattern might also make you weep. If you ask bankers why they are moving into P2P lending, some will point to the high returns they hope to earn (since the average loan commands an interest rate of around 13 per cent, margins are high). Others will cite the need for banks to copy clever technology ideas and become more entrepreneurial.

But there is another, grubbier motive: regulatory arbitrage. “We like P2P because we can do things there that we can’t do in our main bank,” as a senior New York banker recently (and sheepishly) explained at a conference.

Sharp-eyed readers might feel a sense of déjà vu. The idea of using innovations to dance around tough capital rules is hardly new: in the early years of the past decade, banks used structured investment vehicles and collateralised debt obligations in the same way.

They also took advantage of cracks in regulatory structures to create products that policymakers could not easily monitor or control (it was unclear, for instance, who was supposed to oversee mortgage derivatives).

A sense of fragmentation is hampering policymakers again. And as Kara Stein, a commissioner at the US Securities and Exchange Commission, has observed: “We can’t afford a fragmented regulatory architecture.”

It is unclear whether the regulators’ remit covers all the upstarts.

Perhaps this does not matter. The P2P sector is a tiddler compared to the overall financial world (or the pile of mortgage derivatives which sowed havoc in 2008). And unlike the pension funds which were exposed to mortgage-backed securities in 2006, for example, the banks and hedge funds understand the dangers of credit losses. So even if P2P loans turn bad in the future, this should not pose wider risks.

Nevertheless, history suggests that whenever innovation and regulatory arbitrage are combined in an era of ultra cheap money, it often ends in tears — somewhere. If nothing else, that also suggests that policymakers need to find ways to stop activity falling between the regulatory cracks; not least because financiers are endlessly creative at dancing in those gaps.

Copyright The Financial Times Limited 2017. All rights reserved.

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