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P2P Lending: Big, Established Financial Services Companies Should Worry About This Innovation

I would love to get people's thoughts/views on the prospects for P2P lending and why they feel it doesn't get as much publicity/press as other innovations these days a la social networking, crowdsourcing, anything green, etc.

In my view, P2P lending will be huge, and amongst recent innovations, it has probably the best chance of really changing and disrupting the landscape of an entire industry namely financial services. There are, of course, several upstarts in the arena with the most notable being Zopa and Prosper.

For those unfamiliar, P2P lending at a very high-level lets people borrow and lend money to each directly cutting out intermediaries such as banks, credit card companies, etc.

The benefits as you’d probably expect

• Borrowers get lower interest rates
• Lenders get higher interest rates (hopefully after adjusting for risk)
• There is a feel good factor of having lent to someone or some group that needs versus a faceless financial institution that borrows low, lends high

The point, however, is that the idea of people lending to people via a P2P platform is crazy insanely powerful innovation. I’m not sure Zopa and Prosper will be the final guys standing in this market, but in my view, this concept will work and shake up traditional financial institutions. It may not be for many years, but it will happen. Why you ask?

• Look at the unsecured lending markets of the USA, Japan and the UK alone and you see there is a massive market opportunity in just a few large markets.
• And ultimately, the fact that this is a technology platform makes it much more scalable. Entering a new market means customizing the technology for that market (e.g. language, credit rating systems, local laws, etc). I’m oversimplifying here but compare the cost of doing this to setting up a branch network or sending out millions of pieces of direct mail. Much smaller.
• These platforms are classic 2-sided networks. If they can get a sufficient number of borrowers and lenders on board and ensure their credit rating systems are solid so as to prevent large-scale defaults, they become the preferred ‘game in town.’ The growth trajectory can resemble that of eBay which at some point had so many buyers and sellers that other auction services couldn’t gain a similar critical mass.
• Similar to eBay, the services maybe used by small borrowers and lenders today, but over time, the sophistication of these users will increase. eBay which started as a home for beanie-bay hobbyists is now selling fine art and cars. Similarly, P2P lending will go from small one-off loans into small business loans, college and car financing, etc as the platforms, risk and data analysis measures get more sophisticated.
• These services lend themselves to entrepreneurship which ultimately serves to expand the network. Like eBay which has its power sellers, these services will ultimately have their power lenders. In fact, there will emerge a class of people who will be good at borrowing from others on the platform and then lending the same money through the platform. As long as these providers don’t aim to capture all the value of the platform, these cottage industries and entrepreneurs will emerge raising the value of the overall platform. A host of other services that will keep you informed of when your interest rate bid has been trumped by someone else or services that let you assess credit worthiness of borrowers will also emerge which will give people greater comfort with platforms and lead to innovation making them more useful.

So what does this mean for you if you are a big bank and/or credit card company?

• Most likely, this will mean you do nothing dismissing this business as too risky or too small to be worth your time or your risk worrying general counsel will worry about the legal implications. And instead you’ll focus on incremental innovations that are required and necessary but which don’t insulate you from the game-changers that occur occasionally such as P2P. Over time, however, as this model emerges and gains sophistication and traction, you will begin to worry. By then, it may be too late or you will pay a great deal more to enter the business.
• If you’re part of a forward thinking bank or credit card company, you have a few options in my view if innovation is truly important to you:

1. Build – You already have the in-house assets to build this. The technology is not the killer criteria, but instead it is a risk management competency and a brand. Zopa and Prosper are nice names but the vast majority of people haven’t heard of them and most people would rather go to an established brand when giving credit info or lending money.
2. Buy – You could buy one of the existing platforms. I doubt this is an option as I’m sure the founders of these businesses believe (as they should) that they’re onto a ginormous opportunity and so would want a large sum to sell out. This sum may not be worth it at this point for what you are getting.
3. Partner – Perhaps you can private-label one of these platforms and share complementary skills with an existing player. The bank or credit card company offers its risk management capabilities, deep consumer information and trusted brand status and the startups offer the technology skills and entrepreneurial zeal required to get this done quickly. Spin off the venture into a newco if you want. I’m sure the Silicon Valley VCs would beat down the door to get into an opportunity like this.

I’m very curious to see where this all goes, but I do know that ultimately, this will be big. I am also curious to see if any of the big financial institutions think ahead about innovation and put some resources against developing such a platform.

Thoughts?

Sorry for the long post, but it's a topic/innovation which I'm quite optimistic about.

Regards,

Anand Sanwal

Managing Director, Brilliont