Will banking be disrupted by the peer to peer phenomenon?

Savers often complain of the low interest rates they earn. This should ideally translate into happy borrowers, who should be able to borrow cheap. But this logic, although mathematically true, doesn’t work since the intermediary (bank) takes a cut from both ends to fund its high operational costs.

Peer-to-peer (P2P) lending platforms have surfaced to exploit this inefficiency. Much like traditional banks they connect borrowers to lenders, but through online platforms. A lender can either pick a borrower via an auction or choose to spread the funds across a portfolio of borrowers.

Being digitally operated means that P2P lending platforms don’t need to maintain the branch infrastructure which is one of the largest cost components for retail banks. Advantage is passed to both lenders and borrowers. Operational leanness of their business model further reduces costs and benefits the customers.

The phenomenon is gathering momentum. In Britain, P2P loan volumes are quadrupling every year. Zopa, a British P2P lender and one of the pioneers of the concept, has lent more than £700 million in P2P loans. Lending Club, its American peer recently came up with an $870 million stock offering that valued the company at $5.4 billion. Most of the prominent P2P lenders have managed to have stalwarts of the financial services industry on their boards, extending further credibility to their businesses.

Not the same as Payday lenders

A comparison of P2P lenders with Payday lenders like Wonga is noteworthy. Fundamentally, they exist to serve different needs. Payday lenders typically provide instant funds for very short durations (ranging from days to weeks). And, loans can be extended to customers even with poor credit history. Short time duration and high default risk means that interest rates can be exorbitant (APR of 1500% is not uncommon). This has earned Payday lenders the fury of many, including the church.

P2P lenders on the other hand offer funds for longer durations and perform credit checks on the borrowers, much like traditional lenders. A two year loan can be availed at an APR of 5%, which is better than the rates charged by banks on personal loans. Lender can expect to earn 4%, which is again better than what banks offer on deposits in developed countries.

Extends beyond lending

The P2P phenomenon isn’t merely limited to lending. P2P money transfer is also catching traction. TransferWise, a British start-up is a case in point. Instead of moving cash cross-border in the traditional way, it connects users across countries whose funds can be deposited into each other’s accounts in the local currency.

Say Mr A wants to send funds from the U.S. to the U.K. and Mr B wants to send funds in the reverse direction. Instead of following the traditional money transfer method and thus incurring exchange rate cuts for both, Mr A’s funds in USD are deposited into Mr B’s U.S. account and Mr B’s funds in GBP are deposited into Mr A’s U.K. account. TransferWise acts as a matchmaker across thousands of users and money never physically move across borders.

Promise amidst challenges

Despite initial success, there are challenges ahead for P2P platforms. They are still relatively unknown with surveys showing that not more than 10% of the bank users in developed countries know about them. Another concern is that P2P lending is not regulated in most countries and there are no rules on handling the collapse of a P2P platform. Neither are the deposits with P2P platforms insured by government guarantees like is the case for bank deposits. At present, P2P platforms handle no more than 0.1% of the deposits handled by banks but with the early promise they have shown and the inherent strengths of their business model, banks would rather watch out, as the tagline of TransferWise boldly proclaims, ‘bye, bye, banks’.

Also cross-posted here


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