Imagine you’re a small-business owner and a promising project exists in which you’d want to invest; however, you don’t have enough internal capital and you have to raise funds externally. To whom will you turn? Traditional commercial banks may not be the solution because, among other things, stricter regulations make it tougher for them to loan to inherently riskier small-business owners. Additionally, the whole process may take too long, and even if you do receive a loan, interest rates may be too high to offset your increased risk of default for simply being a small-business owner. Thanks to technological developments, however, peer-to-peer (P2P) lending appears to be an acceptable way to resolve this issue. This is because of the P2P lending industry’s ability to offer loans with lower interest rates, while maintaining technologically-advanced and user-friendly online platforms in a culture increasingly preferring to utilize electronic tools and devices (e.g., the innovation of smartphones, face-to-face meeting portals, and webinars). However, regulatory uncertainty may stifle industry growth in the short-term. Lastly, higher-than-desired default rates within the P2P lending industry have become a big issue, but it may lead to increased opportunities for the accounts receivable management (ARM) industry.
The graph below titled Peer-to-Peer Lending Industry Revenue below reveals how quickly the P2P lending industry has grown, as estimated and forecasted by the research firm, IBISWorld. Specifically, the P2P lending industry virtually doubled each year, on average, from an estimated $11.1 million in 2009 to about $1.2 billion in 2015. Going forward, IBISWorld projects the industry to grow to about $3.4 billion by 2020, increasing by about 23% annually, on average.
As an industry still within its growth stage, P2P lending is likely to encounter more demand in non-traditional loans especially as more consumers become more aware and comfortable with utilizing its unique features. We expect this demand will continue to grow for the following reasons:
- The P2P lending industry’s ability to offer lower interest rates to borrowers because there’s no middle-man between lenders and borrowers. This is obviously very appealing to prospective borrowers since P2P loans may effectively be cheaper compared to those originated from standard financial institutions (i.e., commercial and investment banking institutions and credit unions).
- It’s integral for consumer-facing companies to establish user-friendly online platforms in the 21st century. We’ve seen financial institutions and giant retailers significantly develop their online capabilities to compete with one another to earn the money of millennials, the largest generation group in the U.S., who grew up in a technological world and seemingly require everything to be electronic. For example, this led to the rise of Amazon.com, surpassing giant brick-and-mortar retailers like Macy’s and Sears, which are now trying to catch up.
However, as is the case with all new markets, P2P lenders and prospective entrants must be aware of existing regulations and the regulatory uncertainty that shadows the industry. The P2P lending industry is already subject to existing regulations, such as the Equal Credit Opportunity Act (ECOA), the Fair Credit Reporting Act (FCRA), and the Truth-in-Lending Act (TILA), and are bound to extensive licensing and examinations by regulatory agencies. Additionally, there’s significant uncertainty with future rules as regulators have already stated their interests in reviewing the P2P lending industry, potentially setting up even stricter, and more specific, regulations for market participants.
Lastly, the P2P lending industry maintains above-average default rates, which may also lead to greater regulatory concentration and stifle its growth. Prosper and Lending Club, the two largest P2P lenders, experienced default rates of 13.31% and 10.70%, respectively, in 2012. According to Lending Club’s Q2 2017 statistics, 7.74% of their total issued loans since Q1 2007 are either late (1.38%) or charged-off and haven’t yet been collected (6.36%). This amounts to $309.3 million in late loans and $1.4 billion in net charge-offs. Although these data are quite high relative to financial institutions, which generally see lower delinquency rates, they present ample opportunity for the ARM industry seeking to diversify their services into a new, growing market. Many of these delinquent loans maintain interest rates upward of 10-30% (average of 13.59% for Lending Club over the 10-year period), so there’s definitely a lot of revenue potential for collection agencies which are able to successfully enter the P2P lending industry.
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