Introduction: 2008 to Now – As a customer society, we are prone to going to extremes – in terms of our wishes and desires, as well as our forecasts for the near future. If history is any indication, these inclinations can get us into hot water, and oversights and rules evolve as a way to shield us from our own worst enemy – which is frequently ourselves.
It was good-illustrated in 2008. After the home market crash – which was finally caused by poor lending practices and consumer exuberance to assume more mortgage debt than was fair. When the bubble eventually burst and credit availability from conventional banks sharply contracted, a new breed of financial services emerged out of the ashes – the marketplace lenders. Credit-greedy borrowers, as well as Wall Street entire, became enthralled by the concept of rapid, unfettered, deregulated use of loans (would we ever learn our lesson)? Valuations for these companies soared and some even IPO’d; in late 2014, shares of LendingClub surged more than 50 percent on their initial day of public trading.
But since then the prevalent exuberance for marketplace lenders has cooled. Before this season, a string of scandals was exposed, most notably at LendingClub. It had been found the CEO and his family members were really buying LendingClub-originated loans as a means of propping up the company’s sensed marketplace functionality. Also coming to light was the undeniable fact that LendingClub unethically tampered with documents to push through the sale of specific loans. Skittish investors pulled back in the marketplace lenders, so that as investments dried up, unsatisfactory earnings and remarkable reductions in force followed.
Not only were questions percolating round the foil of market lenders, but many were beginning to ask even more profound, more serious questions. With no other resources of earnings beyond loan generation, was the marketplace lending business model even feasible? How would these platforms sustain themselves in case of a capital stiffening, such as, for instance, a recession? As investments dried up, market lenders responded by lowering their lending standards, as well as for several, the home crash was just still too fresh in the mind. Were these “eBays for money” really a good thing – Or a recipe for economic disaster? Naturally, public favor began to sway back toward the established banks, whose charge back rates were consistently proving much more powerful as opposed to market lenders. Many industry watchers overruled their previous stance the traditional banks were absolutely doomed for extinction.
Glimpsing To the Future
If we’ve seen anything in recent years, it’s the dangers of going to extremes – both when it comes to borrowers and lenders over-extending themselves, and also the business in general issuing far-reaching predictions for the future. For every one of their positive attributes, the market financing industry still has plenty of growing to do. Regulation Won’t have to be a dirty word; instead, it can set in place some parameters to aid direct these organizations to some more favorable future.
Also, in contrast to the beliefs of some bold business prognosticators, we shouldn’t anticipate the original banks to fade away anytime soon. In many instances they are piggy backing on the popularity of fintech upstarts as a way to strengthen their own services. Consider Credit Karma’s business model – important financial services businesses advertise on the website, and through advanced analytics, Credit Karma is actually able to route users of their service to such firms, securing a fee in the procedure. We expect to see more collaboration in this way later on.
The same leading financial services firms that once viewed the market lenders as a tumultuous threat, are actually looking to integrate their attributes of speed and convenience to their particular business models. The most renowned example with this is the deal between JP Morgan Chase and OnDeck Capital, where the two collaborated to establish Chase’s fast online lending platform for small business loans in April. As JP Morgan Chase CEO James Dimon eloquently stated, “The marketplace lenders are very proficient at reducing the ‘pain points’ in that they can make loans in minutes, which might take banks weeks.”
Eventually, we are seeing we are also seeing the development of a brand new model known as “composite lending,” which combines the speed and convenience of market lending, with all the reliability and resiliency of established balance sheet lenders, many of which are banks. In the composite financing model, an internet platform is set to facilitate the selling of balance sheet lender-originated loans to secondary investors. The composite giving strategy is likely to be a powerful outgrowth to industry financing tendency, minus the present barriers including viability concerns (outside of loan origination, balance sheet lenders have a few other lines of business that will help insulate them during a downturn) and transparency problems (unlike market lenders, balance sheet lenders do not face extreme pressures to sell off loans all the loans they originate, including the ones that may be high risk).
In conclusion, the future of financial services is just not an all or nothing, black and white scenario, banks versus marketplace lenders. We believe each side can benefit by taking a lesson from the other’s playbook. The marketplace lenders only cannot afford to run wild, and need more controls and supervision. On the opposite side, traditional banks need to seriously consider and address shifting market dynamics and borrower preferences that prize speed and convenience most importantly else. As a recent millennial survey pointedly found, most millennials would favor having a root canal over having to connect to a traditional bank!
Moving forward, the most successful financial services firms are inclined to be those that could employ controls while carrying on the merits of speed and convenience that present market lenders have exhibited can exist. It truly is these players that will emerge as leaders and help create a more prosperous environment for the entire borrower/lender/investor ecosystem.
A Middle Road
A cloud of uncertainty and negativity continues to hang over the market lenders. But, the present state of affairs is probably only a bump in the trail to maturation. In our view, marketplace lenders still have an extremely bright future, because they’ve shown us that speed and convenience are potential in the world of financial services. As an industry, it will be a pity to throw the baby out with the bath water. Rather, what’s needed is some level of regulation and oversight, as a way to protect borrowers, lenders, investors and also the greater market from over-exuberance and excess. What varieties of regulation might help?
First, we have to let loan originators to function merely as originators – Originators really should not be permitted to be originators, agents and/or evaluations companies all rolled into one, as they are in the present market lending business set-up. Joining these disciplines creates a great rage for a lack of transparency. Here’s why: as noted above, most market lenders have no other way to obtain revenue besides originating and selling loans. What this means is they have a vested curiosity about selling every single loan they originate on their books. They may prophesize that they have instruments to assess and carry the threat quantities of those loans, but in the current set-up, marketplace lenders don’t need to disclose any advice they don’t want to reveal. This creates an inevitable conflict of interest, right from the beginning. In other more mature markets just like the traditional stock market, these functions are broken out.
Just licensed agents should have the ability to do trades, and just with sophisticated investors and creditworthy borrowers. In the more mature, traditional stock exchange model, not only would be the jobs of originator, agent and ratings businesses broken out, but prospective brokers should go through in wide-ranging, strenuous process to secure their licenses. Many begin by pursuing finance-related instructions, and after which they have to pass a challenging series of tests. In the United States, brokers are required to get several licenses, such as Series 7 and 63, before they may be permitted to transact business with customers. Agents must fill Continuing Education requirements to be able to show a continuous awareness of conformity. In the current market giving model, essentially anyone working there can issue a loan to anyone. This deficiency of proper qualification – on both broker side, along with the borrower side – can be extremely dangerous.
Finally, there must be an independent outside rating system for loans and groups of loans. These organizations will be similar to the functions of Fitch, Moody’s and S&P in the traditional U.S. stock market. The evaluations published by these credit rating agencies are utilized by investment professionals to assess the likelihood that debts will undoubtedly be paid back. Market financing needs similar centers of expertise, offering independent viewpoints on loan quality, loan performance and individual marketplace lenders’ performance.