Finance & economics | Lending Club

Peer pressure

If you believe the hype, peer-to-peer lenders are coming of age

IT CAN take a couple of weeks for potential borrowers to secure a loan via Lending Club, a “peer-to-peer” platform that matches them up with savers seeking to invest spare cash. The company itself took only five hours to find enough backers to subscribe to its $870m stock offering, valuing it at around $5.4 billion. Its shares were due to begin trading as The Economist went to press.

The growth of “marketplace lenders”, as the online nearly-banks now prefer to be called, has been exponential. Started in 2007, Lending Club is the biggest, facilitating over $1 billion in loans per quarter. That remains tiny compared to the $3 trillion market for personal debt in America. But its rapid progress—loans have roughly doubled every year—has fuelled breathless talk of big banks and credit-card peddlers being “disrupted” in the same way taxi companies have been by Uber, based just down the road in San Francisco.

A confluence of trends has boosted Lending Club and its peers. Demand for loans from creditworthy borrowers has held up even as banks have retrenched in the face of mounting regulation. There is no shortage of willing lenders: once provided mainly by the internet-browsing public, three-quarters of loans are now offered by yield-hungry institutional investors such as hedge funds.

Technology has also made the process of cutting out the middleman that much easier, for example by gauging the creditworthiness of potential borrowers through their musings on social media (best not to tweet about walking away from your electricity bill).

Doing banking without the expensive bits of the industry—branches, creaking IT systems and so on—means that peer-to-peer loans offer lower rates, reflecting their reduced costs (see chart). Most borrowers are refinancing their credit-card debt, swapping a loan on which they paid 16-18% for 12% or so at Lending Club. The company’s focus has been on smaller loans (up to $35,000) to individuals with decent credit ratings, although it is also catering to businesses now.

Peer-to-peer lenders use credit scores as a starting-point to establish a borrower’s creditworthiness in the same way as banks and credit-card companies do. But they say their snazzy credit-scoring algorithms will enable them to weed out probable defaulters better than conventional financial firms do, leading to smaller losses. That is plausible but unproven. Doling out cash in good times is far easier than getting it back in a recession, as seasoned bankers know.

The most appealing feature of Lending Club for those buying its shares may be that it is not a bank. It makes its money by charging fees to both borrowers and lenders but does not take any risk itself. Better yet, if borrowers do not repay their loans, those who advanced them the money do not expect to be made whole, unlike bank depositors. There is no government guarantee, explicit or otherwise.

Lending Club is hardly the scrappy insurgent that it is sometimes painted to be: its board includes John Mack, a former boss of Morgan Stanley, and Larry Summers, once America’s Treasury secretary, along with a slew of prominent venture capitalists. Sustained future profitability will depend on the accuracy of the premise that banks are no better at gauging a customer’s creditworthiness than this new breed of newcomers and their crowd-sourced insights. If that proves to be more than boom-era bluster, banking deserves to be disrupted.

This article appeared in the Finance & economics section of the print edition under the headline "Peer pressure"

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