P2P Lending and Banks: Competition or Opportunity?
Given the rapid growth of P2P consumer lending platforms and other direct online lending groups, one could logically conclude that traditional banks might be big losers as a result of this new form of competition. By some estimates, over $4.4 billion of US P2P consumer loans have been originated already, and the industry’s largest players are currently growing at an annual rate of approximately 200%*. Just when banks have rebuilt their balance sheets and seen their stock prices recover to pre-Global Financial Crisis levels, along comes this new form of financial disintermediation.
Do banks have the skills and competencies required to compete with direct online lending platforms? Do banks possess that unique combination of technological know-how, digital marketing expertise, sophisticated credit underwriting algorithms, strategic focus and aggressive entrepreneurship that LendingClub, Prosper, and a host of other platforms seem to evidence? Perhaps the most serious aspect of this new competition is that these platforms go to the very heart of what banks do, namely – originating, underwriting, and syndicating loans. These platforms, therefore, could be seen as threatening, in an almost existential sense, the traditional “brick and mortar” banking industry.
Banks – and bank investors – need not despair. Indeed, these direct online lending platforms, which are sprouting up across the globe (not just here in the US), could in fact become the banks’ friends and business opportunities. How is that possible? There are at least two ways that banks (particularly small and medium sized banks or, as they are called in bank-land, “community” and “regional” banks) can take advantage of these burgeoning platforms. First, banks can become investors just like you and me – they can purchase loans on these platforms. Think about it, these loans would be a diversifying asset class for many banks’ balance sheets, would add significant yield, reduce operating expenses [and, if data-mined properly, could bring in new clients that the bank is simply not reaching through its current marketing strategy]. Second, banks could purchase or “white label”/rent these direct online lending platforms for themselves and grow their own P2P lending operations.
According to the Federal Reserve’s website ( www.federalreserve.gov ), there is a little over $3 trillion of consumer debt outstanding in the US of which $1.2 trillion, or a little over a third, is held by depositary institutions. If P2P consumer lending platforms can grab a mere 5% market share of the banks’ consumer lending business, that equates to about $65 billion of loans. With an average 9% return (after charge-offs) on P2P consumer loans, that’s a conservative 250 basis points (2.5%) above an average bank’s yield on earning assets. Let’s also conservatively estimate that generating loans over a P2P platform will save the average bank another 50 basis points of operating margin. That means there is a potential revenue enhancement to the banks on the order of nearly $2 billion annually – and that is just with a 5% US market share assumption in the consumer lending vertical (the math: ($65 billion x 2.5%) + ($60 billion x 0.5%) = $1.95 billion). Factor in potential market share gains in small business loans, student loans, and other types of credit and the revenue pool gets much, much bigger.
To get at this potential $2 billion annual revenue pool, a bank just has to become a client of a direct on-line lending platform, deposit cash, and then select the loans that meet its criteria. There could be some technology expense to do that or to outsource to a firm to do that, but it will certainly be a smaller expense than compensating bankers and paying the overhead associated with making these loans. Alternatively, a bank could build, buy, or rent a direct online lending platform. That could be a difficult decision for a bank, because it demands technological know-how and the possible cannibalization of an existing lending business. Banks that follow one of these two paths, however, stand a chance of reaping great rewards. A third and very unpleasant alternative for banks is to wait and watch as an entire eco-system begins to develop around direct online lending – and see all sorts of players, new and old, grab market share and revenues. I believe we have seen this movie once before in the music industry when it was impossible to believe that songs (think loans) could be bought and sold online and not at Tower Records.
Some banks have already become involved in this industry. WebBank, a small, state-chartered industrial bank based in Salt Lake City, Utah, industry giant Wells Fargo, and niche trust bank Millennium Trust (to name a few) are providing banking services to various direct lending platforms. And investment banks are certainly pitching for potential M&A and IPO business. But an educated guess as to how this plays out with respect to the thousands of small and mid-sized banks in the US is as follows: some banks will adapt, developing the nerve, the know-how, the strategy, the relationships and the technology to jump into the direct on-line lending pond; others banks will stay on dry land and continue their search for sustenance in an increasingly arid and inhospitable landscape.
Bill Ullman, Senior Advisor, Orchard Platform