The following article is a guest post by Brad Walker, CEO of Income&.
Peer-to-peer lending has been one of the fastest growing segments in the financial technology sector for the last several years. Prosper, Lending Club and several other P2P firms are enjoying remarkable growth. The most recent numbers show that loan volumes at both firms have roughly doubled over the last 12 months.
Even before the Federal Reserve nudged interest rates up a quarter point to 0.5% last December, a few banking industry analysts had begun to argue that the growth in P2P lenders was likely to slow down soon. Their argument held that higher interest rates would lead to higher loan default rates, which would eventually lead to the collapse of the “speculative bubble” surrounding the sector.
Although the valuations of both public and private P2P firms have taken a hit over the last few quarters on this theory, this hypothetical scenario has yet to play out in reality, as there has been little evidence of a notable slowdown in loan origination volumes or an uptick in defaults to date. Moreover, the Fed has apparently paused in its interest rate hike cycle due to extreme volatility in financial markets and concerns about a global economic slowdown.
Interest rates are, however, clearly a major concern to P2P firms, as both Lending Club and Prosper slightly increased the rates borrowers must pay for loans shortly after the Fed announced the rate hike in December.
P2P firms evolving their business model for continued success
One of the key factors behind the success of the P2P model to date has been the decision to focus on specific underserved markets in the initial phases of developing the business model. A thoughtful assessment of the lending landscape and careful underwriting of the target segments havae put these businesses in the sweet spot for success.
Smaller P2P players such as On Deck, Funding Circle and Kabbage focused on the small business lending sector, and eventually refined their underwriting to the $100,000 to $200,000 range, an area that is underserved by the traditional banking sector. This kind of carefully focused underwriting has enabled these firms to keep loan default rates low and investors happy.
When interest rates do eventually go up, continued growth from this segment of the P2P industry will come from staying nimble and looking for other underserved sectors as increased regulation pushes big banks out of direct retail lending operations. This kind of carefully managed “evolutionary” growth could provide enough revenues to validate the current high industry valuations and turn the bursting of the “speculative bubble” into more of a blip than a crash.
Technology another key aspect of P2P firms success
The success of the P2P business model, however, is about more than making loans available to underserved markets. It’s also about leveraging technology to make the loan process an order of magnitude easier and less time consuming than getting a loan from a bank.
It’s not just that filling out a loan application is faster and easier using a web form, or that the loan application processing time for a P2P loan is much less. The P2P loan process is simply less stressful. It’s more anonymous in the sense you are not asking a loan officer for a loan, and the psychological stress of a “rejection” is less if its automated and impersonal rather than being delivered by a person.
Technology also makes it possible to keep operational overhead very low relative to traditional banking operations, making it possible for P2P firms to offer borrowers highly competitive interest rates.
It can also be argued that the ongoing success of the P2P sector offers other fintech firms some perspective and possibly even a road map for success. Fintech firms with ground-breaking business models in any segment can learn from the success of P2P firms. If these new enterprises have done their homework and found a viable market niche to exploit, then they too should eventually be able to develop an “evolutionary” growth strategy to create their own success stories.