Origins of Online Marketplace Lending

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Finance buzzwords come and go, but the truth is that while “marketplace lending” is a term that has only been bandied about for a decade, the concept itself can be traced back to the roots of civilization itself. The concept of ‘interest’ was also invented, except back in the day you would trade goods for harvest grain or base a contract on verbal agreements. Nowadays, thanks to technology, marketplace lending is much more sophisticated and has enabled businesses to seek and obtain greater working capital.

Having access to credit is integral to achieving business and economic growth, but historically, banks and other financial institutions have been the sole gatekeepers of credit. Online marketplace lending is a concept born out of the frustrations that accompany traditional borrowing methods. Due to its low-cost structure, marketplace lending offers advantages such as increased financial incentives to both borrowers and investors, and also creates access to credit where it was previously limited or not readily available.

Although the industry has faced increased scrutiny from regulatory bodies, no significant regulation that has been imposed has negatively impacted marketplace lending yet. Marketplace lending has untapped potential to help refinance a large amount of existing outstanding debt, and for that reason alone it’s definitely worth keeping a close eye on this asset class.

Marketplace lending is sometimes referred to as ‘peer-to-peer’ lending. It’s a relatively new kind of online lending, as a result of the 2007/08 financial crisis. In a nutshell, it uses financial technology (online platforms) to connect consumers or businesses who are looking to borrow money, with investors willing to buy or invest in the loan. In the majority of cases, once a loan is made, the platform then collects interest payments from borrowers and sends it to investors.

The basis for marketplace lending is that it creates a new investment opportunity. It is the attractive risk-adjusted return, along with the ease of lending, which has made this form of investment compelling in many countries. This type of alternative investment has grown rapidly in recent years. It acts as a disruptor to traditional financial institutions (banks) by connecting borrowers to peers so that they are able to obtain loans at lower interest rates, and lenders or investors can earn higher risk-adjusted returns on their money in comparison to a savings account.

Online marketplace lending has experienced significant growth and innovation since its inception around 10 years ago. Now, you have companies like Lending Club, Sofi, Prosper and Funding Circle are offering quicker loan processes and easier access to capital. Using technology and big data, these online marketplaces have evolved into structured networks. These structured networks include partnerships where institutional investors and banks engage in direct lending and securitization transactions.

Some critics question the longevity of online marketplace lending and whether this is a phenomenon which will be short-lived. However, the outlook is optimistic. Without legacy expenses and high-cost functions needed to service an aged book, marketplace lenders are already ahead of the lending curve. There are four main opportunities (bank partnerships, regulatory reforms, consolidation and diversification, and intensified lobbying) as well as some challenges (higher capital costs, increasing customer acquisition costs, and growing competition) that marketplace lenders will face going forward as they continue to expand and grow.

While there may be opportunities to strengthen the foundation of the industry for long term growth, marketplace lenders will increasingly find themselves needing to demonstrate that they are ready for increased regulatory oversight, and that their business model will remain viable in any credit environment – not just borrowing which falls outside banks’ risk appetite.

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