The moment of truth for marketplace lending
Marketplace lenders (MPLs) have emerged in a unique environment of depressed interest rates.
Whilst the competitive foundation behind the idea of MPLs is that they offer better terms to lenders and borrowers by cutting out the middleman, i.e. the bank, price may not be their best selling point.
In fact, well into the second decade of marketplace lending, the price advantage of MPLs is highly debatable.
But sharp growth in the industry over the last five years is not.
As interest rates rise, we might find that MPLs true advantage over incumbents lies not in price, but in user experience, and their ability to serve previously unserved parts of the market.
Those MPLs that are delivering significant value outside of price, such as in speed of decision making and user experience, will find themselves less impacted by a changing interest rate environment. This is especially true in product areas such as the invoice financing space, where speed is more of a priority for the client than price.
As well as outperforming on speed and user experience, armed with fresh ideas, modern technology stacks, and advanced credit underwriting models, these businesses have been able to offer credit to businesses that banks have largely neglected.
Businesses serving previously unserved parts of the market have exciting opportunities ahead by short-cutting product distribution through hybrid partnerships with banks. This is especially true of MPLs in the small business space, where, having struggled for years to properly serve the UK’s smaller businesses with credit, some banks see the MPL products as complimentary to their offerings, rather than competitive.
Those MPLs looking to build direct distribution channels also have reason to cheer, with investments in brand starting pay off. A recent survey found that 11% of businesses would actively choose to borrow from a peer-to-peer lender as their first choice finance provider.
Rising interest rates could begin to place more strain on loan books, and so it’s time for MPLs to start thinking hard about loan book management. One route could be to use supply chain partnerships to become more sophisticated at managing a scaled loan book. For example, in debt recovery we could see partnerships with high-quality debt collection agencies which could limit the impact of borrower defaults on lender returns.
And then there’s the ISA.
Whilst ISA season is not what it once was, this will be the first ISA deadline on which investors can shield their MPL investments with the UK’s largest platforms from tax within an ISA wrapper.
Unlike the general trend of banks’ pricing of cash ISAs, it looks as if MPLs are keen to pass on all the extra net returns to investors, rather than taking a cut for their bottom line. This is a smart move. The Innovative Finance ISA is something the industry lobbied hard for because they knew it could help take the concept of marketplace lending more mainstream. A key signal of the likely long-term health of MPLs will be their ability to use ISAs to onboard significant numbers of new investors (rather than just boosting the returns of existing customers).
Our report last year argued that the idea that disintermediation necessarily means better prices for customers is overly simplistic and ignores how the bank’s cost of funding advantage outweighs MPLs operational advantage.
Whilst a new economic environment of rising interest rates will place the price point of MPL loans under more stress, there are other important advantages MPLs can leverage in order to continue their impressive growth trajectory.