The Financial Times reported that Wells Fargo, the largest U.S. bank by market value, is banning its employees from lending on peer to peer lending marketplaces such as LendingClub and Prosper. Whether this ban endures or not - blanket restrictions like these have a way of easing as new industries come into the mainstream – the announcement nonetheless brings to light several important topics surrounding how major incumbent banks view Online Lending, as well as the overall brand of P2P lending as it grows in prominence as an asset class.
You can read the FT article here, reposted on CNBC without paywall.
Wells Fargo’s decision seems to rest on two main themes, ethics and competition. Let’s explore these in detail.
From the article, we learn that the decision was made by “ethics administrators” at the bank. There are many cases in which banks rightly restrict their employees from engaging in certain transactions. For instance, employees who have access to non-public information about an investment banking client are typically not allowed to trade in that client’s stock. This restriction is often broadened to include all employees, just to be safe.
However, the principal reason for such restrictions – that certain parties may have access to non-public data – does not apply in the world of Online Lending. Not only is the full set of borrower data available equally to all investors on the platforms, but the data are also fully anonymized. No personally identifiable information is made available, meaning that even if a borrower happened to be a customer of Wells Fargo, there would be no way for an investor to know this and certainly no way for an employee of Wells Fargo to gain information that would give them any advantage in the market.
It is understandable that a corporation wouldn’t want its employees to engage in a competitive activity. Wells Fargo obviously wouldn’t want its employees to do work on the side for another lending institution or to open lending businesses of their own while employed by Wells Fargo. However, this particular case seems to suggest a misunderstanding of what it means to be an investor vs. a lender. In Wells Fargo’s consumer lending businesses, the bank pulls credit bureau data, underwrites applicants, and originates loans. In P2P lending, the platforms (LendingClub, Prosper, etc.) perform these activities themselves, but the people investing money on these platforms do not. These people are not lenders; they are investors. If you as an individual invest in a loan on Prosper, for example, you are not actually lending money to a consumer. Prosper has lent the money to a consumer, and you are investing in a note whose payment stream is dependent upon the performance of an underlying loan, which is entirely serviced and maintained by Prosper. So, the investor in this case is not truly engaging in lending, and, as discussed above, not aided by any of his/her employer’s assets in making these investments. Therefore, it would seem to us that this activity, in terms of competitiveness, would rank somewhere close to owning the stock of another banking institution, and it would probably be a safe bet to say that a good number of Wells Fargo employees own Citi, Bank of America, Chase, or American Express somewhere in their portfolios.
The other competitive consideration would be around representation, that employees investing in Online Lending might be seen publicly as either representing the bank or acting on its behalf, and that there could be an adverse impact to the bank’s reputation resulting from the actions of an employee-investor. This is not an unreasonable concern, as banks such as Wells Fargo are very much in the public eye and subject to daily scrutiny from the media as well as regulators. However, we believe the inherent structure of P2P lending mitigates this concern. If a borrower receives a $10,000 loan through LendingClub, for example, all he knows is that he now has a LendingClub loan. He doesn’t know if the loan was funded by an individual or an institution. The only borrower point of contact is with LendingClub itself as the origination and servicing platform, and there is no way to determine the identity of the investor(s). If one of the investors in the borrower’s loan happens to be a Wells Fargo employee, the borrower would never know, and it is hard to see any potential for confusion that the borrower would think that Wells itself made the loan.
Unbundling, Decentralization, and the Future of Banking
In the last few decades of the 20th century, large banks grew both organically and by acquisition in pursuit of the “financial supermarket” model. From an economy of scale perspective, there was an argument to be made that a bank with a large branch network and centralized risk management and operational functions would be able to offer the complete universe of financial products, and that customers would appreciate doing all their banking in a single place. While this strategy had some merit, the internet has lowered the barrier for new entrants, decreased the advantage of incumbents, and reduced switching costs for consumers. “Unbundling” is transforming a number of industries, perhaps banking most profoundly. Union Square Ventures‘ Andy Weissman provides a great overview of the phenomenon in his recent blog post: Banking and Unbundling.
As much as the ethics and competition topics discussed above, Wells Fargo’s new policy may be an example of how a new incumbent reacts to a potentially disruptive new business model. This particular case notwithstanding, many large banks are actively exploring how they can participate in this market. For instance, the FT article reports that Citigroup, Barclays, and Deutsche Bank are looking into related bond-structuring opportunities. Blackrock made a highly-publicized investment in Prosper; several community banks are now investing on P2P platforms; and last week, Orchard participated in a panel discussion with LendingClub and Prosper at an event hosted by Citigroup. In fact, funds that investors deposit with Prosper are actually held in an FDIC-insured deposit account at Wells Fargo.
It is fascinating to watch the transformation of a massive industry, and the actions of incumbents and new entrants, as well as the interactions between them, are interesting to observe. What is certain is that Online Lending is now “big enough to matter” and holds great promise for being a major piece of the future of finance.