I asked a former chief investment officer of a huge bank a couple of years ago which bank would buy up P2P firms first. They replied: “no, which P2P firm will buy a bank?”
Deloitte’s report this week on marketplace lending (MPL) suggests they were wrong. It concludes that the success of P2P lenders is a “temporary phenomenon” which, “contrary to a number of commentators”, it sees as “unlikely to pose a threat to banks in the mass market”.
In a best case scenario for MPLs, where interest rates remain at rock bottom and banks do not innovate, Deloitte’s modelling suggests they could hope to take a maximum of 6 per cent of the addressable market by 2025.
In a (perhaps more likely) scenario where interest rates normalise and banks continue to innovate, the market share would be just 1 per cent – £500m of loans.
On a cost question alone, this shifts the debate from whether P2P poses a threat to banks to whether the industry actually has what it takes to flourish.
The sceptic’s case
P2P has brought much-needed access and transparency to borrowers and lenders. Platforms also aim to deliver better returns than banks, and have been helped by an ultra-low rate environment. But banks are still cheaper – from the cost of funds to origination and servicing.
As Deloitte points out, banks are able to borrow cheaply, funding a “significant proportion of their balance sheets by taking current account deposits that are inherently less sensitive to changes in base rates than other sources of funding, such as term deposits”.
This gives them a considerable structural cost advantage over MPLs “if and when the credit environment normalises… [we] believe that MPLs’ costs will rise by more than banks’ as the credit environment normalises and interest rates increase.”
Indeed, one investment banker says the report should have gone further, because it only compares “fully-loaded” (direct and indirect) costs of banks and MPLs.
“It’s not the fully-loaded cost that’s most relevant… but the marginal cost. Banks already have the branches and marketing and services infrastructure set up to support the full suite of their products at large scale. Marketplace lenders… are paying through their noses and outspending each other to acquire customers.”
When rates rise and we go through another credit cycle, it’ll be even harder for platforms to match banks’ pricing and maintain a sustainable profit. “Right now, MPLs are underpricing banks simply by offering VC-funded free money to customers and investors.”
Read more: What will happen to P2P in a downturn?
This, he points out, is fine so long as there’s money there. But as and when the money runs out, it can’t be made up on volume. According to Avant chief executive Al Goldstein, VC firms have poured $2.5bn into MPLs, but funding peaked in the second quarter of 2015, and has been dwindling since.
This could bite all platforms, including those that have turned to a “hybrid model” – partnering with banks to originate and issue loans, says the investment banker.
“The hybrid model only provides… more diversified funding sources and stability. It doesn’t change the reality that they won’t ever be able to make money without doing something drastic like selling to a bank or becoming a bank.”
The optimist’s case
But not everyone sees things in the same way. “Banks can currently access money more cheaply than marketplace lenders and, in order to be truly competitive, this gap must reduce,” says Rhydian Lewis, co-founder and chief executive of RateSetter. He’s confident that marketplaces will grow and experience economies of scale, without the need for deposit-taking.
“The route to this for lending platforms is to build up trust and acceptance, which comes with a strong track record. As more people accept the idea of taking some risk for a better return, our cost of funds will decrease, meaning that we are able to compete on a more even playing field with banks, despite the implicit subsidies which they receive,” he adds.
Robert Wardrop, executive director of the Cambridge Centre for Alternative Finance at the University of Cambridge, expands on this. “The as yet unanswered question is, ‘will P2P lenders be able to command a pricing premium relative to banks, even in a tougher macro environment?’”
Imagine a business, which has debt embedded in its operational capabilities, is concerned about the continuity of funding, flexibility around repayments or access to funds. It’ll be more likely to pay a premium to the provider that can satisfy those concerns.
And crucially, if the P2P sector can build lender and borrower confidence, this “trust premium” will narrow, says Wardrop. “There is the opportunity to greatly diminish the competitive advantage banks have through sourcing deposits.”
Read more: Will transparency be enough for P2P lenders?
While Deloitte mentions that banks can borrow cheaply (from depositors), it doesn’t cover other major distinguishing features that give them a competitive advantage: like the fact they hold a credit balance with central banks, or that payments systems also enable them to get money cheap.
“The report suggests a static environment in the future; there are a lot of variables that are going to impact relative positions, and one is definitely around payments,” says Wardrop.
With the Bank of England currently looking at the implications of launching a digital currency, and new payments apps emerging every couple of months, the notion that banks will de-couple from the payments industry doesn’t feel too extreme.
“The ‘unbundling bank’ has profound implications around how they’ll actually lend money in the future. A lot of business lending is done at a loss against risk-adjusted pricing. In a world of decreased cross-subsidisation, they’ll have to start recovering the full risk-adjusted pricing of loans perhaps more so than today,” says Wardrop.
Of course, at a time of an industry scandal centred on US giant Lending Club, the Deloitte report, in highlighting that MPLs will never bring down the banks, reminds the former of what they must focus on: being better for the consumer.
There is, for instance, creeping evidence of maturity transformation (borrowing short and lending long) starting to occur on some platforms, but investors not realising.
More dynamic financing will help the sector mature and grow. But it must be done honestly and with transparency. “There’s always a dark side to trust,” says Wardrop. And just like the banks, MPLs will have to grapple with that.