Social Lending in 2016

2015 was the year of peer to peer lending. Prosper, Funding Circle, SoFi and LendUp each raised over $150 million and originations reached new, staggering heights. Prosper originated $3.7 billion in loans, more than doubling their previous year’s originations, and Lending Club is estimated to have originated around $8 billion in loans in 2015. Globally, the origination volume has been doubling annually, and is set to reach a jaw-dropping $290 billion by 2020.

So, with peer to peer lending the hottest thing in fintech right now, let’s take a look at the likely developments, both in europe and across the pond, that will shape 2016.

Social Lending in 2016 - The key factors to consider

Institutional investors will play an even bigger role

When Zopa launched in 2005, the idea was a simple one: the democratisation of finance. Everybody above the age of 18 should be able to receive the funds they need, if a large enough number of lenders could be persuaded to part with their cash.

The reality of this philosophy could be observed in their US counterparts as well, Lending Club and Prosper, where all loans in 2008 were fractional. This meant that individual lenders parted with a little bit of cash and came together to collectively fund bigger loans.

Peer to peer lending has come a long way since then, although not all developments have been for the better. One trend we observed in 2015, and will only grow in 2016, is the increasing number of institutional investors hogging the p2p market.

Around 80% of all loans on Lending Club and Prosper are funded by institutional investors, to the detriment of the ordinary lenders which supplied the bedrock of these platforms in the beginning. What has caused this shift? Well, two factors are primarily responsible:

1. Social lending has proven itself as a highly profitable enterprise
2. Yields on money markets continue to be abysmal

Thus, peer to peer lending has come to the attention of fund managers seeking higher yield investments.
As social lending grows further, and credible alternatives remain few and far between, we expect the number of fund and asset managers participating on p2p platforms to increase significantly in 2016.

Regulation will shape the global discourse on social lending in 2016

As in any part of finance, the regulators will have a huge say in the developments of peer to peer lending in 2016.
With the market size constantly growing, however, and the nature of the beast continuously changing, regulations are often proved obsolete shortly after coming into effect.

In the UK, the Financial Conduct Authority has been regulating the domestic industry since 2014. To its credit, the body has gone to great lengths to craft a set of rules and regulations specific to peer to peer lending in the United Kingdom, addressing specific risks faced by the people involved.

In the US however, regulation is far less specific, and is often the result of precedent cast by an overlapping industry. Additionally, and in great contrast to the UK and Europe, the lack of a tailored regulatory corset has stifled the industry in the US, inhibiting growth and innovation. As an example, take peer to business lending in the US. You may have noticed it is almost non-existent, despite being a thriving market across the pond.

This is vexing because, where implemented, P2B provides a crucial financing option for small businesses with nowhere else to turn to grow and maximise their revenue. Unfortunately they so often find it impossible to comply with the muddled legal framework, that they fail to operate on a meaningful scale.

Shifting economic policy will affect p2p lending platforms like never before

On social lending platforms, interest rates are designed to correlate with the risk of default. So, if the risk of default goes up, so do the interest rates. Once the risk of non-repayment goes down, then so do the interest rates. Simple enough.

The Federal Reserve on the other hand, increases or decreases its interest rates in accordance with the general health of the US economy. The economy is strong? Interest rates are kept high. The economy is showing signs of weakness? Interest rates are lowered. This mechanism is basically how economies around the world battle inflation and deflation, keeping prices stable and purchasing power on an even keel.

Thus, with the US economy finally showing signs of strength, the FED raised short term interest rates for the first time in nearly a decade, in December 2015. Macroeconomic policy changes such as this will play a vital role in determining the success or failure of social lending platforms in 2016.

As Lending Club put it:
“…fluctuations in the interest rate environment may discourage investors and borrowers from participating in our marketplace, which may adversely affect our business.”

The ways in which the FED can impact p2p lending is manifold, but two potential developments are most likely:

1. Fewer borrowers take out loans, as they chose to wait until interest rates settle
2. Returns on traditional assets will rise and therefore become more appealing to institutional investors, resulting in withdrawals of huge sums of capital

As origination fees are the key source of revenue for peer to peer marketplaces, a decrease in the number of borrowers, or a decline in the number of successfully funded loans, will have a huge impact on the health of social lending platforms in the US.

Thousands of miles away, peer to peer lending will face similar challenges from economic policy in europe in the near future, as the ECB pursues an aggressive fiscal agenda. Pushing its deposit rates further into negative territory and increasing bond purchases will result in an increase in commercial lending from europe’s biggest banks, challenging the arguments for p2p platforms.

One potential benefit for social lending platforms may be, that banks decide to pass on the cost of negative interest rates pushed on them by the ECB. This would result in mass withdrawals and a desire to reinvest or store that money somewhere safe and profitable. Peer to peer lending companies may well provide the perfect alternative.

On the other hand, if borrowing becomes cheaper and more readily accessible from commercial banks, borrowers may well decide to go the traditional route and pursue funding from banks rather than social lending platforms.

Either way, europe is currently sailing into unknown waters and it remains to be seen what the effect of peer to peer lending will be in 2016.