The exponential growth of the peer-to-peer lending industry has drawn the attention of more than just investors. Institutions, including banks, are looking to get in on a good thing.
Such growth also means attention from regulatory agencies, governments and those whose job it is to watch the world of finance. Count Fitch Ratings in that latter category. The venerable ratings agency has been making more public statements about alternative finance of late, which is only to be expected given the institutional and regulatory attention those industries have received.
Brendan Sheehy, a Fitch Director, recently released a commentary on several issues related to peer-to-peer lending, including regulation, benefits and pitfalls, and where the industry could be headed.
Peer-to-peer lenders enjoy several advantages over their traditional competitors, Mr. Sheehy writes. The applications they use are technology-driven and easily scalable, which means they can adapt well to growth surges like the ones P2P has seen. Operational costs are markedly reduced due to the removal of the intermediary (traditionally the banks) from the process altogether. “A portion of these cost savings are then passed through to consumers and small businesses via lower borrowing rates,” Mr. Sheehy observed.
When discussing global industry patterns, Mr. Sheehy notes the industry “is highly fragmented” and mostly operates on a “country-specific basis,” leaving open the question as to whether or not a regional, continental, or even larger area player could some day emerge, just as they have in most other areas of finance. Mr. Sheehy said the largest markets are the U.S., United Kingdom and China.
Another interesting aspect of the P2P industry is the success many lenders are enjoying by targeting a niche market, such as medical or educational loans. The antithesis of the large faceless lending institution, niche lenders offer some degree of specialization in a sector which can convey personal attention that is in stereotypical short supply at traditional institutions.
The immediate future is bright for the industry, with continued growth highly probably, says Mr. Sheehy. “It is currently supported bylow interest rates, the benign credit environment, evolving regulatory dynamics, robust institutional-investor support, as well as growing acceptance of e-commerce among consumers.” Mr. Sheehy notes that save for a market downturn or unexpected event, originations should continue to increase for the near term.
Longer term, the industry faces an uncertain future, Mr. Sheehy believes, including how it will act from an inevitable happening that many in the industry either seem to be ignorant of or are closing their eyes to. “Despite its potential, I would say that the P2P lending industry is still in the early stages of its development, and it remains uncertain if the business model is defensible longer-term against adapting competitive forces and shifting market conditions — in particular, rising interest rates and normalizing credit performance.”
Like many, Mr. Sheehy finds it interesting banks are starting to become involved in the sphere. He does not address this from the angle of confirmation of the fledgling industry, preferring instead to limit his analysis to the pluses for each side from such a partnership. “One recent interesting trend has been the growing number of strategic partnerships between banks and P2P lenders. P2P lenders get access to more stable lower-cost funding while banks benefit from improved operating efficiency.”
But there are risks, Mr. Sheehy notes. Actual benefits of each partnership will be dependent on a host of factors, especially “prudent management.”
Peer-to-peer lending’s future will of course significantly hinge on the regulatory stance various governments will take to it. One only has to look at America’s glacial approach to crowdfunding for an indication of how many governments will address P2P.
“We believe the regulatory authorities will take a slow, thorough approach to understanding the industry and ensuring that the appropriate regulations are in place,” Mr. Sheehy predicts. “I expect that regulators will need to ensure that investors — in particular, retail investors — are adequately protected as well as well-aware of the embedded risks within P2P lending, while at the same time ensuring that consumers and small businesses continue to have access to this lower-cost form of credit.” Note the exact same statements are made by U.S. regulators who oppose or who are at least cautious of crowdfunding.
Mr. Sheehy ends his comments with interesting thoughts on an easy way to make sure P2P platforms take adequate steps to protect investors. “I believe effective regulation, including implementing the appropriate safeguards as well as mandating that P2P lenders retain a portion of the credit risk, can actually benefit the industry by reducing investor concerns and adding a legitimacy to the business model.”
To watch Mr. Sheehy’s comments in full, click here.
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