Written by Oleg Seydak, CEO, Blackmoon Financial.
For the last seven years, marketplace lenders have been a magnet for VC money. Hundreds of millions of dollars were poured into a variety of these tech-enabled, data-driven marketplace lending platforms – some have even IPO’d. Marketplace lenders were, in many ways, in the right place at exactly the right time. With the financial crisis as a backdrop, these new players seemed to re-invent lending in a way that highly regulated, traditional financial services players could not. They did this by quickly matching borrowers with a lack of capital, with investors with money to lend.
Today, Wall Street’s exuberance for marketplace lenders has abated a bit, due in large part to a series of scandals that have caused many to question these companies’ internal controls and whether their lending practices are truly transparent. As secondary investors have grown skittish and pulled back, revenue streams into the marketplace lenders have tightened, which of course has led to a series of disappointing earnings and missed targets.
This, in turn, has caused pundits to question the viability of the marketplace lending business model in the first place. If a marketplace lender’s business depends entirely on originating loans –and they have no other source of revenue – can the business withstand a significant liquidity crunch, like in the case of a market downturn? Not only have Wall Street and institutional investors grown wary, but so too have consumers. In March, the Consumer Financial Protection Bureau (CFPB) announced it is now accepting complaints from consumers and advising on important information consumers should consider before accepting a loan from a marketplace lender.
Don’t Dismiss Marketplace Lending Just Yet
Before we dismiss marketplace lenders as a flash in the pan, a fleeting trend whose time has come and gone, we should pause. The current market skepticism may be real and justified, but in reality, the marketplace lenders are just experiencing inevitable bumps in the road to market maturity.
There are several promising signs that the marketplace lenders are moving in the right direction. One marketplace lending platform recently set up its own hedge fund, with the express purpose of purchasing loans it originates. This kind of foresight can provide a buffer to marketplace lenders in times of tight liquidity. In April, several leading marketplace lenders announced the formation of the Marketplace Lending Association, whose goal is to provide a forum for leaders in the industry to discuss and tackle the unique challenges, risks, and opportunities faced by participants in the sector. The Marketplace Lending Association will also require its members to adhere to a specific set of operating standards that are designed to promote responsible lending, governance and controls and foster the industry’s growth.
Furthermore, while the United States Treasury currently has no direct regulatory oversight over the marketplace lenders, they have outlined several recommendations to facilitate the safe growth of marketplace lending, while fostering affordable access to credit for consumers and business. Some of these recommendations include greater regulatory oversight; standards to ensure a sound borrower experience; the creation of an independent private sector industry for tracking loan performance; and greater collaboration with community development financial institutions, to promote the growth of business in low-income areas.
In summary, the marketplace lenders are taking the right steps, and have taught us that speed and convenience can exist in the lending process. These important lessons should not be ignored. As J.P. Morgan Chase & Co. Chief Executive Officer James Dimon noted in his recent memo to employees, marketplace lenders “are very good at reducing the ‘pain points’ in that they can make loans in minutes, which might take banks weeks.” Established financial services, who once viewed these upstarts as a threat, are now smartly looking to mimic or tap into their speed and convenience.
As one example, Chase – which, like other large banks, typically sat on the sidelines of SMB lending – has been growing more vocal about their middle-market push. It may not be the case that Chase is looking to compete with marketplace lenders, as much as they may wish to use them to scout out the talent that may need more capital to finance their growth. In this sense, it’s predicted that big banks are beginning to view marketplace lenders not as competitors, but potential collaborators.
As the marketplace lenders continue their path to maturation, we are also seeing the emergence of a new model known as “composite lending,” which combines the speed and convenience of marketplace lending, with the reliability and resiliency of established balance sheet lenders, many of which are banks. In the composite lending model, an online platform is deployed to facilitate the sale of balance sheet lender-originated loans to secondary investors. The composite lending approach is expected to be a robust outgrowth to the marketplace lending trend, but without the current obstacles including viability concerns (outside of loan origination, balance sheet lenders have other lines of business that can help insulate them during a downturn) and transparency issues (unlike marketplace lenders, balance sheet lenders do not face intense pressures to sell off loans all the loans they originate, including those that may be high-risk).
Conclusion: The Future Remains Bright
Don’t let the recent dour headlines fool you. The future of marketplace lending, and online lending in general, is in fact very bright. Like any industry sector, marketplace lenders just need some time to mature, and they’re experiencing inevitable “growing pains.” In the meantime, traditional banks are taking notice and incorporating the positive aspects of marketplace lending into both their existing business models, as well as new services. In addition, new approaches like composite lending are bringing together the best of both the “old” and the “new” financial services worlds. In the end, we are likely to see a richer, more robust ecosystem of players, which will help lead everyone involved – borrowers, the lending platforms themselves (both marketplace lenders and balance sheet lenders), established banks and secondary investors – to a more prosperous future.