Is banking about to be “Uberised”?
Lending money to individuals and businesses is at the heart of what banks do. But the rapid growth of alternative lenders, such as peer-to-peer platforms, is fuelling predictions that banks will suffer similar market share losses to those being inflicted on traditional taxi drivers by Uber, the ride-hailing service.
Driven by low interest rates and sub-zero yields, many private investors and hedge funds have poured billions into new peer-to-peer, or marketplace lenders. These platforms match borrowers and investors directly, outstripping banks by offering both higher yields to investors and faster, cheaper, more convenient loans for borrowers.
The lightly regulated entrants, which include Lending Club, Funding Circle and Prosper, have been aggressively seizing business from banks that have been reducing the riskier parts of their balance sheets in the face of heightened regulatory scrutiny.
“All the competitive threats to banks coming from the technology sector are growing,” says Renaud Laplanche, founder and chief executive of San Francisco-based Lending Club, the biggest marketplace lender.
He cites the growth of online lenders in consumer loans, a move into payments by tech groups like PayPal and a challenge to asset managers from new “robo-advisers” that generate automated portfolios for investors.
The new challengers have attracted some of the former titans of Wall Street, including John Mack, former chairman and chief executive of Morgan Stanley and Lawrence Summers, former US Treasury secretary, who both sit on the board of Lending Club.
Insurers and asset managers are also snatching market share from traditional banks by launching direct lending arms. In the UK, M&G and Legal & General are among such groups now lending to midsized companies.
Investors worldwide have raised almost $80bn for direct lending funds in the past two years, as they tap into rising demand from small businesses for alternative sources of finance, according to data analysis firm Preqin.
McKinsey’s recent global banking annual review forecast that technological competition would reduce the global banking industry’s profits from non-mortgage retail lending, such as credit cards and car loans, by 60 per cent and revenues by 40 per cent over the next decade.
A smaller chunk — between 10 per cent and 35 per cent — of profits and revenues would be lost from payments processing, small- and medium-sized enterprise lending, wealth management and mortgages, the consultancy said.
PwC, the consultancy, forecasts that new peer-to-peer lending in the US will swell to $150bn a year by 2025, up from $5.5bn in 2014.
Overall, P2P lenders still make up a relatively small proportion of lending. Morgan Stanley estimated in a recent report that they accounted for 1.1 per cent of all new unsecured consumer loans in the US last year.
But Samir Desai, co-founder and chief executive of small business P2P lender Funding Circle, says: “We have been called small for many years but if you keep growing at 100 per cent a year for many years, eventually people will stop calling you small.”
Funding Circle is now lending £80m a month, which Mr Desai says makes it the fourth-largest net new lender to UK small businesses, even if this is less than 4 per cent of the £6.8bn banks lent to small- and medium-sized businesses in the three months to June.
European policymakers are pushing companies to tap the capital markets for funding in preference to their traditional reliance on banks as they continue their attempts to de-risk the banking system. At present, about a quarter of European corporate finance comes from bond markets, compared with about three-quarters in the US.
In America, about a quarter of loans to small- and medium-sized companies come from the country’s 60-odd “business development companies”. These alternative lenders — such as Prospect Capital, Ares Capital and American Capital — have raised a total of $65bn from equity investors and debt markets to make subordinated loans to smaller companies and pay earnings back to shareholders after deducting fees.
“We have a 2 per cent market share of new consumer loans in the UK, but we are growing at 80 per cent a year and I think we have a realistic chance of getting to a 20 to 30 per cent market share,” says Giles Andrews, co-founder and executive chairman of Zopa, the UK’s oldest P2P platform.
P2P lenders say their algorithmic credit scoring technology is as good as the banks. But because they do not need to hold regulatory capital or liquid assets, operate expensive physical branches or deal with costly legacy IT systems, they are more efficient than banks.
Mr Laplanche at Lending Club and Mr Andrews at Zopa say the “frictional cost” for their companies in making a loan is equal to about 2 per cent, against about 5—7 per cent for a typical bank. “One of the key advantages is that we are able to operate at a significantly lower cost,” says Mr Laplanche.
As a result, P2P lenders can offer investors a higher yield than banks do to depositors. Funding Circle says its investors have achieved a weighted pre-tax average annual return of 7 per cent since its creation five years ago.
Rhydian Lewis, co-founder and chief executive of Ratesetter, says that as the P2P model proves itself, its cost of funding should fall, allowing the platforms to offer loans at even lower rates to less-risky borrowers. “If people start pricing us as a safe place then we will become much more competitive,” he says. “Ultimately we want to be in more mainstream products.”
The yields offered by P2P are alluring. Lending Club cites an average interest rate of 15.47 per cent for its five-year loans, much higher than the 0.39 per cent yield of one-year US government debt. It does not always work out so well, though. Data collated by independent NSR Platform show Lending Club’s 2008 loans now have a negative annual return on investment of 3.4 per cent — those figures are calculated on a different basis to Lending Club’s and do not take account of late fees for overdue loans.
Many bankers privately forecast that the next big financial crisis will blow away these P2P lenders because of the financial and reputational impact from rising defaults among borrowers in a downturn.
But there are already signs that the banks take them seriously enough to team up with them, with many traditional lenders investing in P2P exchanges — such as Metro Bank in Zopa and Citigroup in Lending Club.
One of the first examples is ING, which recently teamed up with fast-growing US marketplace lender Kabbage to launch an online platform in Spain that aims to break into the small business market by offering loans of up to €100,000. The Dutch bank claims that on average it takes a client three to eight weeks to get a small business loan in Europe, while it would take only seven minutes using Kabbage’s technology.
Mr Laplanche says: “It doesn’t need to be a confrontation between banks and the tech sector. It can be a partnership between banks and innovators.”