For Renaud Laplanche, it began with a bank statement — or a pair of statements. Laplanche, then an executive at Oracle, was reading the fine print on his bank-issued credit card statement and another for his savings account and compared the two. If he didn’t pay off his credit card, the monthly interest on what he owed would be 18.99%. Meanwhile, his interest rate on his savings was a mere 1%. “That’s a big spread,” he says. So, he started making calls and talking to people in the industry to find out why.
“It became quickly apparent that most of the spread comes from cost and inefficiencies in the banking industry,” says Laplanche, who figured there had to be a better way. The result was Lending Club, which was launched in 2007 and is now one of the world’s leading peer-to-peer lending platforms. Lending Club — which is backed by Google — has more than doubled its annual loan volume each year since launching in 2007 and expects to extend more than $2 billion in personal loans this year.
Services from companies like Lending Club allow consumers to bypass banks and borrow money from other individuals. They aggregate supply and demand in a more cost-efficient way than banks; the savings allow them to offer borrowers loans at lower interest rates than banks while offering investors who choose to lend a higher rate of return — typically 6% or higher.
Laplanche keeps checking his statements to see if his bank is catching up. “I don’t think the banking industry has really embarked on any massive cost reduction that would help lower the spread, which is why we are growing so fast,” he says. “We’re really capturing market share from the credit card issuers and the larger banks.”
Following the financial crisis banks have retreated from the unsecured loans market and requirements that they hold more capital against riskier forms of lending. U.S. peer-to-peer lending platforms have filled the gap: this new industry is on track to loan out $3 billion in 2013, Ron Suber, the head of global institutional sales for Prosper Marketplace, the second-largest American peer-to-peer lending platform, told Lendit, the sector’s first conference in New York in June. Prosper saw its fifth consecutive month of record growth in July with more than $30 million in loans – more than double the amount the loans it made possible a year earlier. As of July, Prosper had originated loans of more than $580 million since it began in 2006.
The total market opportunity is about $85 billion a year, Suber said, based on the most creditworthy borrowers served by the credit card industry. But online P2P lending platforms don’t have to be competitors.
Lending Club’s message to banks attending Sibos is, “partner with us,” says Laplanche. “We have proven we can originate loans at a lower cost than the banks. The banks should benefit from it and become investors in our platform and capture the extra spread.”
U.S. lenders Titan Bank (based in Mineral Wells, Texas) and Washington, DC’s Congressional Bank have already signed on to offer consumer loans through Lending Club. “This is the future of bank lending,” Titan Bank Director Jonathan Morris said when the deal was announced.
The banks benefit not only from the lower costs of finding and vetting loans but also from the diversity of loans. In the U.S., Laplanche says, Lending Club allows regional banks like Titan to lend beyond their traditional local territory. Lending Club, meanwhile benefits from the banks’ low-cost access to capital.
“To combine the banks’ low cost of funds with our low operating costs, you create the lowest possible cost structure and that really helps us deliver lower interest rates and better service to customers,” Laplanche says, adding that Lending Club is in discussion with other banks.
It’s a model that is being watched closely by online lending platforms and banks overseas. For example, Banco Santander, the Eurozone’s biggest bank by value, has begun initial talks with the UK’s Funding Circle about collaborating. Funding Circle Chief Executive Samir Desai told The Daily Telegraph in August that although talks were in early stages, it is a sign that social lending was “transitioning to the mainstream.” The talks follow the British government giving Funding Circle a vote of confidence by allocating £20 million (about $31 million) to be loaned through its platform.
And Funding Circle, a British peer-to-peer lender focused on lending to small companies, says it has had some informal discussion with banks. The U.S. model is “certainly a blueprint for how it could be working in the UK,” says Funding Circle spokesman David de Koning, spokesman for Funding Circle.
In Britain, the peer-to-peer business lending market has the potential to grow more than ten-fold to £12.3 billion ($19 billion) in annual loans within a decade, according to Nesta, a British charitable enterprise that promotes and fosters innovation and invention. Seventy-seven percent of borrowers interviewed by Nesta said they would return to a peer-to-peer service for their funding needs.
De Koning says Funding Circle’s platform is better for growing businesses because it can provide a loan within a week, whereas at a bank it could take 15 to 20 times longer. “What they need is actually someone who can provide them with the finance and enable that business to continue with the full momentum and growth,” de Koning says. “What they find with a bank is the process just stops them dead in their tracks.”
Online lending platforms are disrupting the banking industry the way iTunes reshaped the music industry, de Koning says. “At first, the Sonys and Universals of this world rejected the model and said, ‘it doesn’t work, we’re completely against it,’” he says. “Then in time, slowly you had U2 started to release an album through iTunes and then you had publishers who were getting onboard and partnering. Nowadays everyone uses iTunes and it accounts for 50% of the market.”
The banking industry is going through a similar process with peer-to-peer lending platforms, says de Koning. “Now we’re in the middle stage where a lot of people are embracing it as the future and a much better way to do finance. You’re getting businesses, institutions and banks looking at it and saying, ‘Okay that’s interesting. It’s here to stay. Is there a way we could possibly partner with it? Or is there a way we could cohabit?’”
Banks can find comfort in the fact that although peer-to-peer lending platforms do not need to hold reserves because individual investors carry the risk, their business model depends on strict risk management, Laplanche says. Lending Club’s Chief Risk Officer Chaomei Chen previously oversaw all risk management for JPMorgan Chase’s WaMu credit card portfolio.
“As we get more data, our risk models are becoming more sophisticated and we have better risk management now than when we started; but the objective has always been the same — to deliver a low-volatility product to the investor base,” Lending Club’s Laplanche says. “A lot of our investors are investing through a retirement account so it’s really important to make sure we deliver a predictable return.”
Like other investors, banks that partner with Lending Club choose how actively they select loans from the platform, Laplanche says. Banks can set their own criteria or superimpose their own credit policy on Lending Club’s and choose a subset of loans that meet their guidelines. Automated loan management options can help banks further cut costs and benefit from economies of scale, he adds.
It’s inevitable that more banks will partner with online lending platforms, says Peter Renton, co-founder of the LendIt conference and CEO of Lend Academy, which teaches peer-to-peer investment strategies. “These online platforms have discovered a way to profitably pursue borrowers with loan amounts of less than $50,000, something that banks have not figured out how to do other than with a credit card,” Renton says. “In the long term, I expect to see banks become more heavily involved in online lending by either buying existing platforms or launching their own.”