Idea behind P2P model was to bypass the mainstream, not become part of it

In George Orwell’s Animal Farm, a group of animals drive out their human masters and establish a co-operative in which all beasts are equal. The target of the author’s satire was, of course, Soviet communism, but it is tempting to see parallels between his fable and recent events in the online lending world.

Just as with the revolt at Manor Farm, this started out as a tale of emancipation. In the wake of a devastating financial crisis, new technology allowed banking customers to slip the shackles of discredited conventional financial institutions and deal directly with each other, cutting out some of the costs and inefficiencies of the bank in between.

The idea of so-called “peer-to-peer” lending was to bypass the mainstream, not become part of it. There was a strong emphasis on community, with loan investors posting personal messages to borrowers. But as the animals in Orwell’s fable fell under the sway of the pigs who stealthily recreated the human system, mainstream finance forced its way back into the picture. First, hedge funds and investment banks popped up as lenders to marketplace operators. Then platforms allowed institutions to invest in whole loans, bringing in the tools of the City and Wall Street in the form of “slice and dice” syndications.

Last month, perhaps the most significant bridge yet was crossed when the pioneer of P2P lending, the UK platform Zopa, announced that it would establish its own bank. True, the change doesn’t mean the lender is abandoning its roots entirely. About 70 per cent of its business comes from consumers lending directly, and it will continue to connect them to borrowers. But the move is — over time — likely to transform Zopa’s business as it allows the platform to get round the biggest barrier to success in the marketplace model: its critical dependence on new transactions for the income platforms earn.

As should be clear from the marketplace name, online lenders such as Zopa don’t own the loans they originate. Most operate as platforms for investors, which means that new business flow is essential for generating revenue. Zopa is a private company and so only makes limited disclosures. But it is possible to see the effect very clearly from looking at Lending Club, a listed US marketplace platform. In its latest quarter, transaction fees accounted for nine-tenths of $112m in revenues.

That wouldn’t matter so much if the marketplace movement’s goals were modest. Retail lenders tend to be sticky and might live with fluctuations in activity. But the sector has been backed by impatient venture capital investors, drawn in by the possibility of rapid expansion followed by a suitably lucrative exit. And their vision depends on platforms seizing a big share of total lending pretty fast.

What has become clear is that there are simply not enough consumer lenders to deliver the objective. Just to reach the $26bn the sector lent last year in the UK and the US, platforms have already leaned heavily on institutional money. And that has turned them into something more like old-fashioned finance companies — increasingly dependent on market access for funding.

Source:  Financial Times