The ABC of Peer To Peer Credit

The financial world has not witnessed much innovation since the 2008 meltdown. This is because any innovation in this sector is scrutinized for possible systemic risks. However, during this period peer to peer lending has evolved. The industry is still in a pretty infant stage. However, in 2015, peer to peer credit accounted for over $5 billion in loans. This represented an almost 100% increase on a year on year basis. Also, in the forthcoming year, a 72% increase is also on the cards. If this trend can be sustained for just a few years, peer to peer credit will become a significant player in the credit markets. Banks and other financial companies are also looking at peer to peer lending as a method to diversify their tightly monitored portfolio. This is likely to fuel the p2p growth even further!

In this article, we will have a closer look at this lending model.

How is Peer to Peer Lending Different ?

Peer to peer lenders do not lend money on behalf of the investors. When we lend money to a bank, the bank acts as an intermediary and invest money on our behalf. On the other hand, a peer to peer lending platform plays the role of a matchmaker. These companies have developed a platform wherein customers need to enter their information. They then have proprietary algorithms which will assess the risk in the requested loans. Based on the risk evaluation and interest rates, the loan opportunities are then presented to the investors. Investors are aware of who they are lending the money to and for what. Also, they are directly accountable for the loans they make. The peer to peer platform just acts as the middleman.

For the consumers, peer to peer lending is different because it gives them access to credit that would have otherwise been difficult to obtain on similar terms. As far as the investors are concerned, peer to peer lending is different because it gives them an unprecedented amount of control over their investments and also the interest rates are considerably higher.

How Do Peer To Peer Credit Companies Earn Revenue ?

Peer to peer companies have a different revenue model. They do not make their money on interest rate differential. Instead they charge a finder’s fee to both the buyer as well as the seller. Also, they take a certain portion of the interest that is paid on the loans as commission.

Collaboration by Banks

One might assume that banks would be fighting tooth and nail against the peer to peer lenders. However, this assumption does not hold ground. Any kind of analysis will show that banks are indeed co-operating with peer to peer lenders.

About 80% of the dollar value of the loans made by peer to peer lender is not made by individuals. Instead it is made by organizations. A large number of these organizations are banks themselves or subsidiary companies that are owned by banks. Banks therefore are simply using the platform provided by peer to peer lenders to make small dollar value loans that are too expensive for them to make if they use their own infrastructure.

There is however, a flipside to banks using peer to peer lending. Modern banks rely on customer service to retain their customers. Also, cross selling is a huge part of the banking business. Peer to peer lending makes the banks offer white label funds to borrowers. As such they cannot demonstrate their customer service or attempt to cross sell when they make loans using a peer to peer platform.

The Innovation

  • Different Evaluation: Peer to peer loans use a different credit scoring mechanism as compared to traditional banks. Therefore people who are disqualified from traditional loans may obtain a peer to peer loan quite easily.

  • Options to Buy Loans: Peer to peer platforms offer investors with a wide array of options. They can decide whether they want to exclusively fund the loans or whether they only want to fund a part of it. Also, they can decide the geographical and financial boundaries within which they want to fund loans. They can also choose the profile of the borrowers they want to provide loans to. Of course, irrelevant information will not be provided to investors to avoid prejudice based on racism.

  • Kinds of Loans: The peer to peer platforms make loans with incredible ease. Earlier, it was because the dollar amounts involved in these loans were small. However, of late, the dollar amounts of these loans have started growing. This is because these platforms now fund mortgages and home loans in addition to small dollar value loans.

Compliance

Banks love peer to peer lending because it helps them circumvent compliance. It is a relatively new form of lending and regulators are not yet abreast of the issues pertaining to peer to peer lending. Therefore, there are almost no rules and regulations. That could be a good point or a danger signal depending on the behavior of the particular platform. In general, both customers and investors would be advised to stay away from peer to peer lenders which have extremely lax lending standards.


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