What is P2P lending and has it become a misnomer?
Peer-to-Peer Platforms (P2P) opened a new frontier in digital lending by connecting individual investors directly to borrowers. UK-based Zopa was a pioneer in this form of crowdfunding, but others like LendwithCare and KIVA offer different models. These platforms channel investors to MFIs that then lend to individuals or businesses. And their success has attracted the attention of traditional financial institutions that don’t typically serve downstream markets.
Institutional investors are taking advantage of the P2P model by using their platforms as intermediaries to reach new clients directly, swiftly and at a lower cost. Other P2Ps like Ondeck offer a different service by referring screened clients to banks. P2P has thus become somewhat of a misnomer since both individuals and institutional investors can now gain a referral or “remote” access to a new client segment through the platform. Prosper, RateSetter, Funding Circle and the now troubled Lending Club demonstrate both the potential and the risks associated with such platforms.
Are these P2P models competing for MFI clients?
Though global data on their client demographics is not yet available, borrower qualification criteria provides some insight into client characteristics. P2Ps generally require borrowers to have a bank account, utility bill, source of income, pay-slip or business revenue documentation and a specified minimum income. Most request credit reports if they are available. These requirements enable lending to a segment of underserved clients to help them manage cash flow as well as SMEs that require small amounts of quick cash. But lending to the unbanked, micro entrepreneurs or those at the BoP is still constrained by these requirements. The poor tend to have irregular incomes and lack pay slips or other official documents like utility bills or credit reports.
P2Ps provide the promise of affordable and fast access to credit – by reducing cost, increasing efficiency and reaching clients whose needs are not being met by traditional FSPs. They provide the interaction platform, find new lenders and borrowers, conduct KYC and screen borrowers by gathering financial background information and using credit checks and proprietary algorithm-based credit models.
They also provide a host of additional services such as relaying the pricing of fees and interest rates and providing a reverse auction function where borrowers can shop for the best interest rates. They process payments between parties, service loans in the event of repayment problems and ensure legal compliance and reporting.
But this process-based and product and efficiency-first model lacks an empathetic connection to clients and their needs. For the model has not utilized the lesson learned from decades of service provision to poorer clients: to tailor products to reach them. Credit scoring algorithms have not withstood the test of time and can too often lower loan origination standards by relying too heavily on technology as a proxy for repayment capacity.
Where are P2P platforms making inroads?
The UK, US, China and Australia are global leaders of the P2P market. British P2P’s did £5.1 Billion GBP in cumulative lending in Q1 of 2016. P2P lenders in the US generated $6.6 billion in loans, a 128% increase from 2014. Though China had 1,700 platforms, nearly 30% failed in the past year turning it into a cautionary tale for investors and regulators.
P2P platforms are a growing portion of Fintech start-ups in India (Faircent and Lendbox), Brazil (Lendico with Banco BMG), Colombia, Mexico (kubo.financerio, a microfinance P2P) and Malaysia (Crowdo and the launch of FundedByMe). Afluenta received funding from the IFC and institutional investor Elevar Equity to operate in multiple Latin American markets. Most of the initiatives in developing economies are relatively new and small in scale but are expected to grow and impact local markets.
Despite the meteoric growth of some, they are not yet causing a large-scale, global disruption of traditional players. Instead, the sector’s transformations are creating new relationships between institutional and retail investors, traditional financial service providers, fintech companies and borrowers. Regulators are also starting to weigh in by deciding how to classify them. As their model evolves they may provide an alternative way to leverage technology to serve a wider client segment.
How Can MFIs benefit from innovations in P2P platforms?
P2Ps are not yet encroaching on core MFI client segments in part due to their lack of ability and experience in reaching that client base. MFIs can leverage P2P platforms to their own benefit by:
- using them as a new source of funding and helping connect them to downstream clients
- investing in P2Ps that have a track record and robust risk management systems in order to reach an upstream client segment
- getting or making customer referrals depending on MFI needs
- utilizing their expertise in financial service provision to create products designed specifically for optimized collaboration between MFIs and P2Ps and to serve clients at the BoP more efficiently and at a lower cost
- developing products with an empathetic view of clients’ needs, balancing efficiency with usability and sustainability
Both MFIs and P2Ps can expand their client bases when they combine efficiency offered by new channels and partnerships with a better understanding of the needs of a broader client base.