Marketplace lending now has dedicated analysts from investment banks charting growth in the industry. That’s a very, very good sign. Marketplace lending is a fairly recent phenomenon in the United States compared to other developed economies, such as China and the UK, but the concept itself has been around forever.
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There are several terms that cover this lending space: alternative finance, marketplace lending, peer-to-peer, direct loans, merchant cash advance, factoring—all are variations on a theme. The simplest way to think about the industry as a whole is that traditional banks aren’t involved. (There are exceptions to this rule, and banks are indeed beginning to test the marketplace waters, but for the sake of this article we will keep the analogy clean.)
Marketplace lenders come in all shapes and sizes. Some are well-capitalized individuals or a group of individual investors putting their own capital at risk in direct relationships with borrowers. These are direct lenders, and they’re popping up throughout the United States. Peer-to-peer lenders, often more closely aligned with the term “marketplace,” are also growing in numbers and transaction volume. This model is different in that they operate on sophisticated exchanges that instantly pair borrowers and investors of all shapes, colors and sizes. The lender side ranges from individuals to institutions and the platforms serve different purposes, such as consumer lending, business loans, and even industry or loan-specific vehicles.
Other common online loan products include receivable factoring (a cash advance on booked income to be collected in the future) and merchant cash advance (MCA)—a cash advance on anticipated credit card income. These methods are more established than the emerging marketplace models discussed above, and they are typically more expensive options.
Because some of the growth is happening off exchanges and out of public view, as in the cases of MCAs and direct funding, it’s difficult to truly assess the growth in this industry. But if companies like Prosper and Funding Circle are any example—both of which anticipate funding in excess of $1billion in loans on their respective exchanges—the industry is growing rapidly.
We’ve spoken here about the current regulatory picture, which is something that will be closely followed by industry leaders and stakeholders in years to come.
Essentially, this industry enjoys less regulation overall than traditional banking because marketplace lenders are non-depository institutions, which means they are taking all of the risk associated with a loan and not placing the public’s money at peril. But less regulation also typically means less transparency, which can obviously be a bad thing in the financial arena. But it’s also precisely the reason growth in marketplace lending is perhaps more important for the borrowers than the lenders.
Here’s why.
Funding Circle (FUNCIRP), OnDeck Capital (ONDK) and Lending Club (LC) have all gone public recently, and Prosper, an online loan marketplace, raised a whopping $165 million this year in advance of an expected 2016 IPO. These companies alone are generating several billion dollars in new loans annually, with more entrants raising private capital in the hopes of joining their ranks. In isolation, these sound like impressive gains, and because these companies are trading in the public, or near-public arena, they are subject to greater scrutiny. Yet in the context of the multi-trillion-dollar debt and lending market that is the United States, marketplace lending is a rounding error in its infancy.
Nevertheless, because there is increased competition in both the private and public marketplace lending spaces, rates have already begun to compress. And that’s a good thing for borrowers.
As the market grows up and legitimizes in both the consumer’s consciousness and on Wall Street, more experienced players are coming into the fold. This, too, is a good thing for borrowers, as better credit decision and servicing platforms become available every day. In the end, it shouldn’t be too easy to get a loan, as the housing bubble demonstrated. But creating simpler, more intuitive platforms is a positive trend already creating envy among traditional bankers.
Increased competition brings more experienced players, who are better able to assess risk and create stability in the market. Competition will also bring about rate compression, which ultimately inures to the benefit of the borrower.