P2P comes of Age
Zopa, the oldest peer to peer lending (P2P) platform in UK, recently broke the £1 billion barrier in loans made through their platform. All other platforms continue to see rapid and unabated growth rates.
Alternative finance doesn’t seem very alternative any longer. This industry is coming of age, transitioning from its “start-up” phase into “adolescence” and moving fast to becoming a high growth, mature and stable market, bringing great benefit to consumers of financial services.
Venture capitalists have taken note and are further fuelling the growth of not only alternative finance but Fintech (financial services transformed by technology) in general. In 2014, global investment by venture capitalists in Fintech grew by 201% to $12.21bn, according to a recent Accenture study.
Thus far, the industry has grown up without any significant growing pains. Defaults have been low and the market has continued to grow without any significant correction or pull back.
To understand where this industry is going, it’s important to understand the key drivers that have fuelled this sector:
Now the big question on everyone’s mind is “Will this good news story continue?” Is this story too good to be true? Is this bubble about to burst?
Indeed, the wider peer to peer lending (or marketplace lending) market hasn’t yet reached its full potential. There are many out there who still aren’t comfortable to invest in it, or borrow from it or promote it (for example financial advisors).
So what’s the answer? In my view, this market will indeed continue to grow. However with a proverbial “but…..” to qualify this assertion. I believe that future winners will have the following characteristics:
Whilst the future definitely looks bright, it won’t be without its challenges.
This market has emerged in a relatively benign credit environment, and has been supported by the artificial quantitative easing implemented by central banks. How will the market stack up against rising interest rates? Will investors take flight to more tried and tested institutions, preferring banks once again, where (at least in UK) their money will be protected by the Financial Services Compensation Scheme?
With exception of a few players like Zopa, the wider alternative finance sector also hasn’t, as yet, been stress tested “through the cycle”. The landscape could change dramatically if the new age peer to peer lending firms prove to be less resilient during a downturn.
In the UK, 2016 marks an important time for the wider peer to peer lending sector, which opens its doors to the ISA (Individual Savings Accounts) tax free investment market in April. Government statistics show that around £79 billion worth of ISA investments was subscribed by investors in 2014/2015. In the same period, the ISA market was valued at £483 billion. All good news for the alternative finance market, but how will platforms cope operationally with a tsunami of funds flowing to them, especially bearing in mind that this market is still under £5 billion in UK? Will platforms introduce greater risk into their portfolios as they are forced to quickly lend out un-invested funds sitting in client accounts? How will they balance liquidity between investors and borrowers?
With unabated growth since inception, is this market overdue for a correction? It’s accepted that at some point, such a correction is inevitable. What many established players are worried about is the likely contagion risk that they may be exposed to because of weaker players failing.
Finally, as the market grows and brings in more competition, already tight margins may be further be squeezed.
Regulation has been fairly light touch to date, especially in the UK. Rightly so, because Government and the regulators were keen to let this fledging industry flourish. However, as the industry grows (especially at the eye watering rate that it is currently growing at), it will give regulators some cause for greater anxiety. This is very evident at the point of regulatory licensing (or authorisation).
The Financial Conduct Authority (FCA) seems to be taking a very considered and cautious approach to letting alternative finance firms through the gate. Many of our clients are now waiting more than 9 months to get authorised, because of this cautious approach. FCA’s remit, when assessing firms, seems to go beyond the minimum regulatory standards.
The FCA are also due to conduct a major review of this new industry in 2016, and it wouldn’t be surprising to see greater regulatory requirements imposed on this sector.
The more worrying trend however, is the fact that regulators (especially in the US) are starting to conceive of the possibility that alternative forms of lending could introduce systemic risk into the financial services sector. Peer to Peer lending is (rightly or wrongly) sometimes classified under the term “shadow banking”, which is a growing concern for regulators.
In a speech made in March 2015, Vice Chair of the US Federal Reserve Board of Governors, Stanley Fischer stated that:
“nonbank firms and activities can pose the same key vulnerabilities as banks, including high leverage, excessive maturity transformation, and complexity, all of which can lead to financial instability.”
Greater scrutiny by financial stability regulators could have significant implications for the peer to peer lending sector. The regulator may substantially increase prudential capital requirements, and impose restrictions on certain types of business activities. Prudential requirements may also be risk based, meaning that platforms will have to implement complex risk measurement solutions to ensure capital adequacy requirements fairly reflect the risks they take on. In addition, requirements for adequate governance and risk management arrangements will intensify.
Could we see Basel III type regulation imposed on peer to peer lenders?
From the high level assessment of this market, I can reassuringly conclude that the future is looking very bright for the Peer to Peer lending sector. However, as this market transitions into “adolescence”, it will inevitably experience growing pains before reaching maturity. New risks will permeate this rapidly growing market, and platforms will need to be extra vigilant to guard against such risks. Regulatory scrutiny may however be disproportionate and excessive as P2P lenders are caught up in the “Shadow Banking “category.
Want a more in-depth analysis? Then watch this video presentation by clicking on the link below.
Jay Tikam is the Managing Director of Vedanvi, a progressive professional services firm dedicated to helping Fintech and Alternative Finance firms overcome business, risk and regulatory challenges.