Wolf here: The New York Department of Financial Services sent a letter to 28 online lenders, requesting information about their online lending activities, “according to a person familiar with the matter,” Reuters reported on Saturday. The lucky recipients include Prosper, the second-largest online lender after beleaguered Lending Club, but also Avant, Funding Circle, and Upstart.
Online lenders have been able to bypass banking regulations so far because they get their money for funding loans directly from retail and institutional investors, and/or from securitization of their loans, rather than from depositors. But now, after the Lending Club debacle, regulators have woken up. Reuters:
The department demanded “immediate compliance” with New York licensing requirements for debt collection, money transmission, and mortgage lending activities, according to a copy of the letter reviewed by Reuters.
The department also requested details about types of loans and fees the companies pay to, or receive from, other financial institutions.
Regulators are trying to show that some kind of broader crackdown is underway, even if, like many other “crackdowns,” it never leads to anything in particular.
So here is FINRA attorney Andrew May, weighing in on the Lending Club debacle and what it means for the future of online lenders:
By Andrew May, FINRA attorney at May Law in Chicago:
Finance has a reputation for being at the cutting edge of technology. It also has a reputation for taking on stomach-churning risks. Both of these tendencies seemed to culminate in what’s become known as Peer-to-Peer lending (the cool kids are calling it P2P).
Birth of the Non-Bank
When you think of lending, most people probably imagine a bank. Everyone you know has a bank account somewhere. People and businesses keep money in their accounts and take out loans. The bank is a middleman, and that’s exactly why its simple business model is in danger. The internet is remarkably good at cutting out middlemen.
P2P is essentially the same business model without an intermediary. Banks aren’t involved, people can lend directly to others, interest rates are low and charges are almost non-existent. It has the potential to change the very nature of the financial industry, and many of the people who understood this invested in the most successful P2P company out there, Lending Club.
Lending Club started off as a little-known app on Facebook back in 2006. A year later, it caught the attention of Silicon Valley investors, raised millions of dollars and launched a massive P2P network. Over the course of a decade the company oversaw more than $1 billion in loans. Even tech giant Google bought a stake, and when the company eventually offered shares in an IPO, it was worth $8.5 billion. Lending Club was the poster child of the still embryonic fintech industry.
But things look very different now. Earlier this year, reports started coming in that employees had noticed suspicious changes to the dates on some of the loans offered through the company. CEO Renaud Laplanche was aware of these discrepancies, but failed to inform the board about them.
To make matters worse, it turns out that Laplanche also owned and failed to mention a stake in an investment fund that was being considered as an acquisition by Lending Club. So it wasn’t much of a surprise when Laplanche resigned, a number of managers at Lending Club were fired, and the stock fell close to 70%.
The debacle left people questioning the viability of the peer-to-peer business model and whether it was worth investing in at all. Additionally, rising interest rates have increased the interest charged on the loans offered by these companies, which has put off some borrowers. The whole industry is now facing something of an existential crisis.
An Unlikely Partnership
Perhaps the problems are overblown though. After all, peer-to-peer lending is not a new concept – it’s been around for years and has proved to be popular with those who need access to capital through less traditional means. Investors who lend on these platforms have shown a keen interest in the higher returns as well.
While fintech platforms struggle with regulatory issues and stagnant revenues, their model might be preserved by more traditional players in finance. Wells Fargo, one of the largest commercial banks in the country, has already declared its interest in these platforms. And SoftBank’s SoFi, a Japanese online lender, may have both the capacity and enthusiasm to buy out distressed assets like Lending Club.
Lending Club’s current management is confident that better supervision will lead the company out of this mess. And they have good reason to be optimistic; the online lending model has met with incredible success in China, and it seems that government regulations might actually help these companies go mainstream.
Tech giants like Google or Apple may even get involved. Of course they have the funds, but it’s their technical expertise that could really make a difference to the industry. Some of the biggest p2p lenders in China are run by well-established internet companies, so a similar model could work anywhere else in the world.
Despite the lower valuations and lack of marginal funding, online lending is well positioned to survive. The demand is just too great to ignore. As people get more accustomed to buying consumer goods online, they’ll increasingly turn to the internet when they need help starting a business or buying property too.
Lending Club’s problems simply highlight issues this industry was likely to face sooner or later. But it’s not the sort of threat that could kill an entire industry. The technology promises a change that many welcome and are likely to get one way or another.
If you want to know the future of this industry, it’s important to realize that big banks and multinational corporations are not competition, but potential partners. Furthermore, peer to peer lending may not look like what investors initially imagined. It might be relegated to the back-office, be more heavily regulated, and look a lot more boring than it did in the past, but the essential service will be available for those who need it. By Andrew May, FINRA attorney at May Law.
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No model survives a thieving management and non existent oversight.
Too many ‘models’ to count….!!
“Over the course of a decade the company oversaw more than $1 billion in loans.”
I think Lending Club did WAY more than that. Last year alone they did 8 billion?
Hard to tell about this one.
Perhaps it was a set-up all along. P2P was given enough permission but the fine print was going to doom them inevitably.
I dipped my toe in this with Groundfloor.com but soon changed my mind. I only put the minimum in but have just retrieved 20% of my money so far. I honestly can picture a higher default rate than the collected interest rate since money is lent to people unable to get loans from conventional lenders. If I really loved hard-money real estate investment, I can join one of many local house flipping groups and use craigslist. A middle man is not really needed.
Couple things scare me about this:
1) They haven’t been around long enough to go through a big recession. Their projected loan default rates may be way off in that event.
2) They are securitizing a lot of the loans which are being bought by the big banks, etc. The big banks have more information about the borrowers than regular people do so they can easily pick off the loans that actually are lower risk.
3) Hackers, identity thieves, etc may figure out a way to scan them and take out a huge number of loans quickly.
But no risk, no reward.
When oh when are we going to stop hearing the old chestnut about banks being merely ‘intermediaries’?
If we are ever going to see P2P lending replace traditional banking, we will need to ensure that circa 97% of our money is generated in an alternative manner…or the money supply will collapse.
We don’t have a “money supply”. We have a “credit supply”.
Next thing you know, these P2P lending sites may provide “loans” that are nothing more than credit entries on the account of the debtor, backed by no money, no currency, no gold, etc. but only account credits……………
Wait, that sounds like ……………..banking…………can’t have that. How dare somebody other than the ruling Banking Families create “credit” out of nothing and charge interest.
My question is, if the book value of their loans covers 58% of their share price, aren’t they a zillion times better the derivatives-laden large banks and many times better than the small banks that churn at 3%reserves????
I don’t fb and did not even realize this business model existed(my bad). No wonder brick and mortar banks are having a hard time originating loans.
As for oversight….the reason for Mandatory Monday Bank closures (hidden in the U.S. now by the Monday Holiday phenomenon)is that fiddles require constant tending. Why not make p2p close for the same three days that brick and mortar banks do?
Who have guessed that lending money to people the banks won’t touch could not work out?