Peer-to-peer lending surges in US, challenging traditional banks

NEW YORK - Josh Smith, a 30-year-old blogger on finance, was in the midst of a career change in 2009 when he sought to refinance US$8,000 (S$11,000) in credit card debt.

"At the time, I was making the transition to freelance," he said. "When I asked the bank, they did not want to lend me the money because I was leaving a permanent position for freelance." Smith turned to the online marketplace Lending Club and had a deal within six days.

"Getting a peer-to-peer loan was incredibly simple," he told AFP.

Led by companies such as Lending Club, which went public in December, borrowing money from other individuals and groups via Internet marketplaces has surged in the United States.

The volume of loans made through intermediaries like Lending Club has jumped an average of 84 per cent each quarter since 2007, according to PriceWaterhouseCoopers.

Total loans reached US$5.5 billion (S$7 billion) in 2014 and are projected to hit $150 billion or more in 2025, the accounting firm said in a February report.

"Think of them as eBays for money," Consumer Reports magazine said in January.

"Just as eBay brings buyers and sellers together, peer-to-peer platforms bring borrowers in need of loans from $1,000 to $35,000 together with investors who want to earn better returns than those offered by banks." Peer lending platforms can give borrowers better rates than conventional banks, while providing investors a higher yield in an era of low interest rates.

The interest rate varies with the risk and generally falls between six and 12 per cent. Prospective borrowers are vetted as they would be at conventional banks, but the process is more rapid.

The companies that serve as intermediaries typically charge between 0.5 and 5.0 per cent of the sum borrowed.

Filling a post-crisis void

The market is booming for peer-lending brokers as banks remain cautious about opening up their loan books in the wake of the 2008 crisis, and being pressed with tighter regulations.

California-based Prosper Marketplace has facilitated $1 billion in loans the last five months and is aiming for $3 billion in 2015, said chief executive Aaron Vermut.

"What I think changed after the crisis of 2008 is that the big banks really left a big vacuum in the lending space," Vermut said.

To limit the risk for lenders, companies like Lending Club and Prosper split loans among different investors. The default rate is three to four per cent, according to the website Lend Academy.

Goldman Sachs said earlier this month that seven per cent of the bank industry's annual $150 billion profits could be at risk from new credit sources in the next five years.

That is pressing conventional banks to refashion themselves to keep up with the new online competition.

"Emerging players will force the incumbents to change competitive behaviour," Goldman Sachs said. "We would expect pricing of products to adjust, driving potentially lower returns." Nessa Feddis, a senior vice president at the American Bankers Association, said large banks would adjust if demand for alternative lending stays high.

"The industry does not see it as a threat. It sees an opportunity," she said. "Many of the banks are indirectly involved with peer-to-peer lending as lenders. Also banks, like other businesses, learn from the competition and evolve."

But Feddis said there was a need for regulators to ensure a "level playing field" between banks and the emerging class of financial players. For example, banks are kept to strict capital requirements not faced by alternative lenders.

But that marks a big difference between the two approaches: peer lending platforms do not take deposits like banks to make their own loans, but are just brokers who take a fee for matching lenders and borrowers.

Meanwhile Vermut said his firm is already "very transparent" about its fee structures.