A temporary phenomenon? - Marketplace lending An analysis of the UK market - Deloitte
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temporary phenomenon? A Marketplace lending An analysis of the UK market
Marketplace lending | A temporary phenomenon? Contents Foreword 1 Executive summary 2 1. What is marketplace lending? 4 2. Marketplace lending: a disruptive threat or a sustaining innovation? 8 3. The relative economics of marketplace lenders vs banks 11 4. The user experience of marketplace lenders vs banks 23 5. Marketplace lending as an asset class 24 6. The future of marketplace lending in the UK 30 7. How should incumbents respond? 32 Conclusion 35 Appendix 36 Endnotes 37 Contacts 40
Marketplace lending |
A temporary phenomenon?
Foreword
Foreword
As explored in Deloitte’s Banking disrupted All these are factors that add to the Our findings suggest that MPLs in the UK
and Payments disrupted reports, and average cost of a loan. Many commentators are unlikely to pose a threat to banks in
Deloitte’s The Future of Financial Services recognise the significant cost advantage the mass market. In the medium term,
report, produced in collaboration with the that this will give MPLs and are highlighting however, MPLs are likely to find a series
World Economic Forum, a combination of the resultant disruptive threat that MPLs of profitable niches to exploit, such as
new technology and regulation is eroding represent to the traditional banking borrowing which falls outside banks’
many of the core competitive advantages business model. risk appetite and segments that value
that banks have over new market entrants. speed and convenience enough to pay a
These structural threats have arrived at This report is our contribution to this premium (for example SMEs, particularly
a time when interest rates are at historic debate in respect of marketplace lending in invoice financing, or high-risk retail
lows, and seem likely to remain ‘lower in the UK. It is based on extensive research borrowers). So while banks cannot afford
for longer’. Combined with an increase in and analysis, including expert interviews to be complacent, they probably have more
regulatory capital requirements, these and a survey of consumers and small to gain than to lose from implementing
changes are making the goal of generating businesses in the UK, which aim to answer a strategy of effective collaboration and
returns above the cost of (more) capital a the following questions: partnering with MPLs.
continuing challenge.
•• is marketplace lending a temporary
At the same time, customer expectations phenomenon? Does it constitute a
are changing. Consumers’ experience disruptive threat to banks’ core lending
of digital in industries such as retail, and deposit-gathering businesses in the
accommodation and transport is UK market? Or is it, instead, a sustaining
heightening expectations for convenience innovation, that does not fundamentally
and immediacy. And consumers are change the financial services landscape
increasingly willing to experiment with new but may instead drive improved
providers, even for services where trust is performance and pioneer the provision
required. This is creating ideal conditions of credit into previously under-served
for technology-enabled entrants to segments?
challenge the integrated banking model. Neil Tomlinson
•• what should (and can) banks do to react Head of UK Banking
Marketplace lenders (MPLs) are leveraging to the emergence of the MPL model?
all of these trends to attack one of the core
profit-generating activities of commercial
banks: lending. The MPL model is built
around modern technology that enables Marketplace lenders (MPLs) are leveraging
highly-efficient customer acquisition,
approval and servicing activities within all of these trends to attack one of
a relatively light-touch regulatory
environment. Most banks’ operating the core profit-generating activities of
models, by contrast, include legacy IT
expenses, significant regulatory overheads commercial banks: lending.
and the mature collections and recoveries
function that is needed to service an aged
book.
1
Marketplace lending | A temporary phenomenon?
Executive summary
Executive summary
MPLs do not have a sufficiently material source of competitive advantage
to threaten banks’ mainstream retail and commercial lending and
deposit-gathering businesses in the UK market.
Marketplace lenders (MPLs) have recently Based on this research, Deloitte draws •• our research suggests that most people
gained prominence following rapid growth the conclusion that MPLs do not have a understand that lending money via an
in markets like the UK, the US and China. sufficiently material source of competitive MPL is not comparable to depositing
This growth, along with an apparent advantage to threaten banks’ mainstream money with a bank. This is largely due to
investor appetite to provide them with retail and commercial lending and deposit- the fact that MPL investments are not
equity funding and use them to channel gathering businesses in the UK market. covered by the government’s Financial
funds directly into consumer and SME Critically, banks should be able to deploy Services Compensation Scheme (FSCS)
lending, has led some to predict profound a structural cost of funds advantage to which protects the first £75,000 of
disruption of the traditional banking model. sustainably under-price MPLs if it becomes deposits. There may be times in the cycle
clear that the threat of lost volumes makes where supply constraints in the banking
Unlike banks, which take in deposits and this the value maximising strategy. Three sector make certain areas of marketplace
lend to consumers and businesses, MPLs key observations underpin this conclusion: lending a more attractive asset class. This
do not take deposits or lend themselves. is unlikely to be an enduring advantage,
They take no risk onto their own balance •• any operating cost advantage that MPLs however, and the capital provided here
sheets, and they receive no interest may have is insufficient to offset the is more likely to be deflected from fixed-
income directly from borrowers. Rather, banking model’s material cost-of-funds income or equity investments rather than
they generate income from fees and advantage. It is our view that in today’s from bank deposits.
commissions generated by matching credit environment, the cost profiles
borrowers with lenders. of banks and MPLs are roughly equal,
meaning neither has a material pricing
This paper looks at the potential for MPLs advantage. However, Deloitte also
to take material share from banks’ core believes that banks will have a structural
lending and deposit-taking businesses cost advantage over MPLs if and when
in the UK market. It tests the hypothesis the credit environment normalises
that, to be truly disruptive, MPLs would
need to possess competitive advantages •• although borrowers currently value
that create real customer value for both the benefits of speed and convenience
borrowers and lenders that incumbent offered by MPLs, these are likely to prove
banks cannot counter. As part of this temporary as banks replicate successful
research, Deloitte commissioned innovation in this area. In addition,
YouGov to conduct consumer and small- Deloitte believes that borrowers who
business research, and also spoke to are willing to pay a material premium to
several UK marketplace lenders, banks access loans quickly are in the minority
and investment managers. Deloitte
also developed a UK ‘MPL opportunity-
assessment model’, comparing the lending
costs of banks and MPLs, and forecasting
the future size of the MPL market.
In this publication, ‘we’ and ‘our’ refer to Deloitte LLP, the UK member firm of Deloitte Touche Tohmatsu Limited.
2
Marketplace lending |
A temporary phenomenon?
Executive summary
We do not believe that the banking model So what, if anything, should banks do?
in the UK will be fully disrupted by MPLs. Our fundamental view is that MPLs do not
Based on our market sizing analysis, MPLs present an existential threat to banks and,
will not be significant players in terms of therefore, that banks should view MPLs
overall volume or market share in the UK. as complementary to the core banking
However, we also do not believe that MPLs model, not as mainstream competitors.
are a temporary phenomenon. They seem We therefore believe that banks can, and
likely to become a permanent part of the should, evaluate a wide range of options
landscape by performing at least two for enhancing their overall customer
valuable functions: proposition by partnering with MPLs.
Options might include:
•• they may provide supply into areas of the
lending market where banks do not have •• providing easy access to such platforms
the risk appetite to participate, such as for borrowing that is outside a bank’s risk
high-risk retail borrowers appetite
•• while the likelihood of a significant •• keeping an eye on evolving credit models
outflow of deposits from the banking
system does not seem strong, MPLs •• leveraging MPL technology to enhance
may offer a low-cost option for certain the customer experience
investors to gain direct exposure to new
asset classes. •• utilising elements of the MPL model to
expand geographically without bearing
the distribution and regulatory costs of
the traditional bank model.
We do not believe that the banking model
in the UK will be fully disrupted by MPLs.
However, we also do not believe that
MPLs are a temporary phenomenon.
3Marketplace lending | A temporary phenomenon?
1. What is marketplace lending?
1. What is marketplace lending?
This section is designed as an introduction Unlike banks, which take in deposits This ‘embedded securitisation’ aims to
to what marketplace lending (MPL) is and and lend to consumers and businesses, minimise the risk of default by spreading
how the MPL model differs from the banks’ MPLs do not take deposits or lend lenders’ investments across a large number
traditional lending model. It also provides a themselves. They therefore take no risk of borrowers.
snapshot of the state of the MPL market in onto their balance sheets (see Figure 1).
the US and continental Europe for Nor do they have an interest income, but MPLs generally update the risk-model
comparison with the UK. rather generate income from fees and algorithms that underpin their credit-
commissions received from borrowers and scoring approach more frequently than
The world’s first MPL, Zopa, was founded lenders/investors. banks do.1
in the UK in 2005. The first MPL in the
US, Prosper, was founded in 2006, and Investors can select the return they require In 2014, US$23.7 billion of loans were
the first in China, Paipaidai, was launched on their investment by specifying maturity issued through marketplace lending
in 2007. Initially, such platforms enabled or risk profile (based on an assessment of platforms globally, concentrated primarily
retail borrowers and investors to contact the credit risk represented by the platform) in the US (51 per cent), China (38 per
each other directly, or ‘peer-to-peer’ (P2P). or through a combination of the two. cent) and the UK (10 per cent). The total
More recently, institutions have begun grew at a CAGR of around 120 per cent
investing in bundles of loans, prompting Most platforms split the money invested by between 2010 and 2014.2 (Please see the
the sector to be named more accurately as lenders into smaller ‘tranches’ and lend it US and European boxes below for more
‘marketplace lending.’ on to several borrowers. information on the respective markets).
Figure 1. Lending business models, banks vs MPLs
Traditional bank lending model Marketplace lending (MPL)
Loan
Saving(s) Loan(s)
MPL
Interest on Interest and
saving(s) loan repayment(s)
Bank (Fees/commissions)
Depositor(s) Borrower(s) Lender(s) Borrower(s)
Loan repayments
•• Banks act as an intermediary between savers and •• Marketplace lenders directly match lenders with borrowers
borrowers. They pay interest on deposits and lend money via online platforms
to consumers and businesses
•• They do not lend themselves, so they do not earn interest
•• They generate income by taking risk onto their balance and do not need to hold capital to absorb any losses
sheets and managing spreads between the interest banks
charge on loans and that paid on savings •• They make money from fees and commissions from
borrowers and lenders
•• This risk-taking requires them to hold capital to absorb
potential losses
•• MPLs use traditional, bank-like, credit-scoring approaches,
•• Depositors have limited control or visibility over how their and publicise these credit risk scores
money is used
•• MPLs offer transparency and control to lenders, such as
•• Banks engage in maturity transformation as the deposits through disclosure on recipients of funds lent out
are typically shorter term than the loans, creating a need
for a liquidity buffer. •• Generally, by design, there is no maturity transformation
involved.
Source: Deloitte analysis
4Marketplace lending |
A temporary phenomenon?
1. What is marketplace lending?
An overview of marketplace lending in the US
Current size of the market
It is estimated that marketplace lenders (MPLs) in the US accounted for loan originations worth approximately US$23 billion in 2015 (see
Figure 2). LendingClub, an unsecured consumer lending platform, is the largest MPL in the US and originated US$8.4 billion-worth of loans
in 2015.3 While LendingClub accounts for a significant share of the market, many other players in the US lending marketplace are focused
on a wide range of individual segments, such as student loans.
Figure 2. US MPL annual loan volumes, US$ million, 2011 – 2015*
$25,000 CAGR:
$22,732 163.3%
$20,000
$15,000
$10,653
$10,000
$4,114
$5,000
$1,529
$473
$0
2011 2012 2013 2014 2015
LendingClub Prosper SoFi OnDeck Avant Other
Source: Direct Lending: Finding value/minimising risk, Liberum, 20 October 2015, p.6
See also: http://www.liberum.com/media/69233/Liberum-LendIt-Presentation.pdf; Deloitte analysis
* Figures are rounded to the nearest million
Notary model (Since February 2016, WebBank has held an Partnerships between banks and MPLs are
The widely adopted model for US interest in newly-issued loans sold via the becoming increasingly common in the US.
marketplace lenders is the so-called LendingClub platform; in return, LendingClub BBVA Compass bank, for example, partners
‘notary’ model,4 in which: pays a ‘trailing fee’ to the bank.)8 with OnDeck to originate small business
loans through the platform by referring
•• borrowers apply for a loan on a Institutional investors customers for smaller loan amounts.12
marketplace platform Institutions, including hedge funds, private
equity firms and banks, provide the bulk
•• accepted loan applications are of lending through marketplace platforms
then originated by a partner bank in the US.9 Such investors, which are able
(LendingClub and Prosper use Utah- to use due-diligence services offered by
based WebBank); the MPL performs the intermediaries such as Orchard,10 can also
underwriting of the loans, using criteria use their own risk models to ‘cherry-pick’
agreed with the partner bank5 under-priced loans on the platforms. (The
Peer-to-Peer Finance Association (P2PFA)
•• platforms purchase the loan from the has prohibited this practice to its members
partner bank6 in the UK.)11
•• the platform issues a note to lenders,
instead of a contract.7
5Marketplace lending | A temporary phenomenon?
1. What is marketplace lending?
Other bank partnerships focus on funding, SEC-registration process, allowing retail One MPL, SoFi, which offers loans to
i.e. rather than simply referring the loan on investment through these platforms. creditworthy students at lower rates than
to an MPL, the bank provides the funding Securities regulations also prevent retail the government or traditional lenders, was
themselves. For example, LendingClub and investors from investing in business loans the first to receive a triple-A rating for a
Citigroup announced a partnership in April in the US.15 marketplace loan-backed securitisation.18
2015 in which Citigroup provides borrowers Prosper, too, has securitised US$327
on the platform with funding through the Furthermore, some state regulations million of its loans with the participation
Varadero Capital hedge fund, which takes prevent retail investors who do not meet of the BlackRock investment management
on the first loss risk. Such arrangements certain eligibility requirements from firm.19
allow banks to provide funding to higher- lending through the platforms. Some
risk individuals or SMEs, while passing states currently prevent retail investment What lies ahead?
much of the credit risk on to investors altogether.16 The US market has already witnessed
searching for yield.13 increased collaboration between banks
Securitisation and marketplace lenders, and Deloitte
Retail investors The development of marketplace lending expects stronger integration of this sort to
The Securities and Exchange Commission in the US has been so strong and rapid take place in the future. Such partnerships
(SEC) views promissory notes14 issued that there is now demand for securities will help marketplace lenders to increase
by platforms as debt-backed securities. backed by marketplace loans, as they have awareness among borrowers and
Securities regulations prevent retail become an investment-worthy asset class investors, gain scale and possibly lower
investors from investing in unregistered in their own right. This has added liquidity their customer acquisition costs.
securities, meaning that retail investors to the market, and may help to lower the
may lend only via platforms that have cost of funding. There were approximately
registered their promissory notes as 40 MPL securitisations up until Q4 2015,17
securities with the SEC. Both LendingClub and the market has also seen its first rated
and Prosper have gone through the securitisations.
The US market has already witnessed
increased collaboration between banks
and marketplace lenders, and Deloitte
expects stronger integration of this sort
to take place in the future.
6Marketplace lending |
A temporary phenomenon?
1. What is marketplace lending?
An overview of marketplace lending in than in the UK may also have constrained Germany and France are the largest
continental Europe growth.20 This may explain why MPLs in MPL markets in Europe after the UK.22
MPLs in continental European markets continental Europe originated just €669 In continental Europe, the consumer
have not benefitted from the same million in loans in 2015 (see Figure 3), lending market accounts for the bulk of
government support or regulatory while UK marketplace lenders originated marketplace loans (see Figure 3). The
approach as their counterparts in the UK. £2,739 million (€3,513 million21) situation is different in the UK, where
A deeper-rooted cultural aversion to risk (see Figure 4). both the consumer and business lending
markets are well developed (see Figure 4).
Figure 3. European MPL annual loan volumes (excluding the UK), € million, 2010 – 2015*
CAGR:
€669 87.3%
CAGR:
€338 €543 88.2%
€165 €174
€284
€9
€65 €3
€23 €29 €6 €26 €32 €6 €62 CAGR:
€126
€54 83.8%
2010 2011 2012 2013 2014 2015
MPL business lending MPL consumer lending
Source: Liberum AltFi Volume Index Continental Europe, AltFi Data, data as of 22 February 2016
See also: http://www.altfi.com/charts/charts/eur-volume_chart.php; Deloitte analysis
*MPL business lending includes invoice trading, figures are rounded to the nearest million
Recent developments in the market For example, French consumer MPL Prêt Aegon, the Dutch insurer, also announced
Currently, there is no pan-European D’Union, the largest player in the French plans in October 2015 to lend €150
regulation that specifically covers market, has raised €31 million primarily million to borrowers through the German
marketplace lending. MPLs are subject to expand into Italy.24 UK MPLs are also consumer MPL, Auxmoney.27
to regulation at a national level. While expanding into continental Europe: Funding
many countries do not have MPL-specific Circle, for example, has acquired German As the market gains traction, we believe
regulation in place, some member MPL Zencap and launched operations in that the unclear implications associated
states, including France, have introduced Spain and the Netherlands.25 with the currently limited regulation may
specific regulation covering aspects lead to concerns about MPLs potentially
such as disclosure, due diligence and The continental European market is also looking to gain scale through imprudent
the assessment of creditworthiness.23 following the lead of better-established business practices and the improper use
Furthermore, the European Commission’s markets with the growing involvement of of client monies. In October 2015, for
Capital Markets Union initiative emphasises mainstream financial institutions. There example, the Swedish marketplace lender
the role that MPLs could play in helping is an emerging trend for MPLs to partner TrustBuddy declared bankruptcy28 after the
SMEs diversify their sources of funding. with banks. This includes the recent platform uncovered alleged misconduct
joint partnership between Sparda-Bank within the organisation, including misuse
Despite such differences between national Berlin and Zencap (now Funding Circle of lender capital.29 Such developments
regulatory frameworks in Europe, a Germany)26 in which the bank provides its have fed existing fears that the failure or
number of MPLs have sought to expand or clients with the MPL platform’s business impropriety of one platform may tarnish
consolidate across borders in an attempt loans as an investment option. the entire industry at this early stage of
to achieve the volume required to scale development.
their businesses.
7Marketplace lending | A temporary phenomenon?
2. Marketplace lending: a disruptive threat or a sustaining innovation?
2. M
arketplace lending: a disruptive
threat or a sustaining innovation?
On the surface, marketplace lending looks It would appear to position MPLs well to According to Deutsche Bank, capital
like a quintessential disruptive force, as it provide a wider base of borrowers with markets accounted for more than 80 per
embraces such structural effects of the faster, more convenient access to credit at cent of debt financing for businesses in the
digital economy as: a lower price point than is achievable by US in Q4 2013, compared to just 20 per
banks, which remain hamstrung by legacy cent in Europe.30
•• the trend towards growing trust in online IT infrastructure and an outdated and
transactions expensive physical distribution network. That is the core of the argument stating
that the traditional bank lending model
•• increasing consumer expectations of At the same time, by offering investors faces profound disruption, and there is
immediacy access to profitable asset classes that had some evidence to support it. MPL-based
hitherto been the exclusive preserve of the consumer lending in the UK grew at a
•• the proliferation of public data (for risk banks, MPLs appear capable of threatening CAGR of 81.2 per cent between 2010
scoring). the core deposit-funding base of the banks and 2015. SME lending (including invoice
if deposit customers can be attracted to trading) via MPLs experienced even faster
MPLs appear set to overcome structural the higher yields and easy, transparent growth, growing at a CAGR of 171.6 per
barriers to entry such as banks’ extensive access they offer. cent during the same period (see Figure
branch networks and privileged access 4). Furthermore, the total number of
to customers and their data. The use of In many ways the situation appears active borrowers using UK MPL platforms
digital channels, streamlined processing analogous to the rapid growth of the almost doubled in 2015 alone, rising year-
and innovative risk scoring, combined with securities markets in the US. This witnessed on-year from approximately 140,000 to
a model without the compliance costs of a dramatic reshaping of financial services approximately 275,000, as of Q4 2015.31
highly-regulated bank intermediation, is as loans and deposits left the core banking
certainly advantageous. system, attracted to the solutions offered by
the new ‘technology’ of the capital markets.
Figure 4. UK MPL annual loan volumes, £ million, 2010 – 2015*
CAGR:
£2,739 109.4%
CAGR:
£1,114 81.2%
£1,534
£568
CAGR:
£648 £1,625 171.6%
£125 £80 £284 £966
£57 £11 £57 £34 £205
£68 £91 £364
2010 2011 2012 2013 2014 2015
0.05% 0.96%
0.003% 0.51%
MPL business lending MPL consumer lending MPL share of total consumer lending MPL share of total business lending
Source: Liberum AltFi Volume Index, AltFi Data, data as of 26 February 2016
See also: http://www.altfi.com/charts/charts/uk-volume_chart.php, Office for Budget Responsibility, Deloitte analysis
*MPL business lending includes real estate loans and invoice trading, figures are rounded to the nearest million
8Marketplace lending |
A temporary phenomenon?
2. Marketplace lending: a disruptive threat or a sustaining innovation?
In addition, the amount of direct equity investment in MPL platforms (UK MPLs raised more than US$220 million in equity capital in
201532), and the amount of institutional money being channelled through MPLs into consumer and SME lending, suggest that sophisticated
players are backing this sector to grow significantly.
Figure 5. Estimated aggregate institutional participation in loans originated by Funding Circle, Zopa and RateSetter
120 30%
Loans originated (monthly, £ million) and share of institutionally funded loans (%) 110.6 111.8
103.4
98.4
Share of institutionally funded loans
100 25%
88.5 86.1
84.0 85.9
80 20%
Loans originated
71.0 68.4
62.1 62.7 84.1 81.2
57.8 59.1 80.6
60 52.2 53.4 15%
76.9
71.5 65.5 70.1
40
70.4 10%
61.9 56.1 64.5 61.1
53.3 57.4 57.5
52.1
20 30.6 5%
22.8 21.5 26.5
17.0 20.4
16.0
0.1 0.1 0.2 0.4 1.6 7.3 13.6
6.6 6.5
0 0%
Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15
Loans funded by institutions Loans funded by retail investors % of loans institutionally funded
Source: Is ‘P2P’ Lending a thing of the past?, AltFi Data, 19 May 2015
See also: http://www.altfi.com/article/1055_is_p2p_lending_a_thing_of_the_past, Deloitte analysis
Finally, any search for a personal loan on key aggregator sites shows the increasing pervasiveness of MPLs. Overall, MPLs look highly
price‑competitive, particularly for lower-value loans (see Figure 6).
Figure 6. UK personal loan annual percentage rates (APRs) for three-year duration loans, MPLs and banks
35% APRs (%) by loan value
30%
25%
20%
15%
10%
5%
0%
£1,000 £5,000 £10,000 £25,000
MPLs Banks
Source: MPL and bank websites, Uswitch.com, Deloitte analysis. Data as of 23 February 2016
9Marketplace lending | A temporary phenomenon?
2. Marketplace lending: a disruptive threat or a sustaining innovation?
The key question is whether the momentum we are currently witnessing could progress to cause a profound disruption
of banking (and possibly some elements of asset management), or whether MPLs will turn out instead to be a ‘sustaining
innovation’: one that forces incumbents to up their game in core markets and that may pioneer the provision of credit into
previously under-served segments, but that does not fundamentally change the financial services landscape.
Given that the market-penetration achieved by MPLs is to date still well below one per cent, and that the ability to lead the market for
pricing on loans does not necessarily indicate superior or sustainable risk management or cost control, it is worth investigating such broad
assertions in detail. Essentially, the case for MPL disruption is built on four potential sources of sustainable competitive advantage:
a fundamentally lower-cost operating model
an ability to use public data to (safely) overcome incumbents’ data advantage in scoring risk, potentially going on to
achieve better risk-pricing by taking a more agile ‘Big Data’-based approach
a superior customer (borrower) experience, driven by speed and convenience
an ability to better absorb and diversify risk by matching the appetite of borrowers and investors for both risk and
duration.
The next three sections review these factors to understand whether MPLs constitute a truly disruptive threat to banks. We then use our
findings to determine our view on the potential market size of marketplace lending in the UK.
10Marketplace lending |
A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
3. T
he relative economics of
marketplace lenders vs banks
Banking has a reputation as an expensive Mid-market/SME banking in general has We have examined the costs incurred in
form of financial intermediation. After all, proven to be an asset class where the cost originating and servicing a loan through the
if banks provide the most efficient way to of securitisation outweighs its value, leaving traditional bank model with an equivalent
borrow, why would so many of the world’s banks as the main source of funding. loan originated and serviced through an
largest borrowers rely instead on the MPL. This analysis does not compare the
capital markets? So, have MPLs found ways to overcome total costs of operating a bank to the total
these cost barriers and provide a lower costs of operating an MPL.
However, there have historically been potential price-point than the banks at
limits to the scope and reach of the capital these lower loan values? Below we look
markets. Borrowers need to be of sufficient at the relative costs of various loan types
scale to justify the investment required offered by the traditional bank lending
to gain a credit rating, and must also be model and the MPL model.33
prepared to disclose the information
necessary for securities to be issued.
Figure 7. Cost economics of illustrative bank and MPL loans
Bank loans, % of loan amount (bps)
+200 bps -85 bps
800 bps
720 bps
+200 bps
+270 bps 460 bps
+215 bps
Loan operating Deposits Funding Loan Fees, Total – Unsecured Total – Retail Total – Unsecured
expenses operating costs losses commissions personal loan buy-to-let mortgage SME loan
expenses and other income
MPL loans, % of loan amount (bps)
+45 bps 815 bps
+500 bps
715 bps
500 bps
+90 bps
+180 bps
Operating Operating expenses Loan funding Platform Total – Unsecured Total – Retail Total – Unsecured
expenses attributable to costs (ie. return funding costs personal loan buy-to-let SME loan
attributable to lenders to lenders) mortgage
borrowers
Source: Deloitte analysis
11Marketplace lending | A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
Whether or not MPLs have a pricing The costs of loan-making include the direct It will also incur marketing costs, lender-
advantage over banks depends primarily costs of funding and liquidity (such as the processing and servicing costs and other
on three factors: the cost of funds; interest rates, yields and returns payable non-interest expenses. In addition, the
operating expenses; and how they price on these funding sources). Furthermore, platform itself must be funded, and the
risk. While operating expenses of MPLs attracting and retaining deposits involves MPL must be able to pay a return to its own
are most commonly compared with more than just paying interest: banks must investors. Unlike a bank, however, an MPL
those of banks, we believe that a holistic also provide payment and processing does not need to incur the costs associated
comparison including funding costs is services; most must also run a branch with offering current accounts, such as
necessary to reach an accurate assessment network; and they will incur significant providing payment services and running a
of the two models’ relative economics. regulatory and marketing costs and other branch network.
non-interest expenses. The true cost of
Cost of funds attracting the funds to the bank must take In Figure 8, we examine these ‘fully-
For banks and MPLs alike, funding costs account of these non interest-based costs loaded’ costs, comparing the total costs
are a major component of a loan’s total of gathering deposits.34 of attracting funds into banks versus the
cost profile. To make a true comparison costs faced by MPLs. Two observations are
between the expenses incurred by each However, borrowing via a bank may give key. First, the total funding costs for banks
type of institution, we have examined the the borrower access to a wider range of are lower than for MPLs. Second, the non-
respective costs of attracting the funds services, such as international payment interest component of an MPL’s funding
they require to participate in the loan- systems, which are not part of the MPL profile is proportionately lower than it
making process. service offering. Banks may be able to is for a bank. We therefore believe that
generate income from these services and MPLs’ costs will rise by more than banks’
For a bank to make a loan, it must first the borrower may see value in “one-stop- as the credit environment normalises and
attract deposits, wholesale funding and shopping”. interest rates increase. Figure 8 illustrates
equity onto its balance sheet and must this point, using a scenario where base
maintain liquidity reserves to meet the For an MPL to make a loan, it must attract rates have returned to 200 bps, and credit
needs of its customers. lenders. Clearly this involves offering spreads are at pre-crisis levels, to show the
returns that outweigh the risks that lenders estimated increase in these ‘fully-loaded’
are prepared to take on. funding costs.
Figure 8. Costs of funding an unsecured personal loan: banks and MPLs, current and normalised credit environments
Bank loan, % of loan amount (bps) MPL loan, % of loan amount (bps)
Total cost of
attracting funds:
total increase: 795 bps
Total cost of 25%
attracting funds: 90 bps
Total cost of
attracting funds: 635 bps 55 bps
Total cost of
attracting funds: total increase: 530 bps not interest
13% 90 bps rate sensitive
470 bps
45 bps
not interest
270 bps
rate sensitive
270 bps interest rate 650 bps
sensitive
70 bps 500 bps
50 bps 65 bps
interest rate
60 bps sensitive
90 bps 125 bps
Current credit Normalised credit Current credit Normalised credit
environment environment environment environment
Equity Wholesale Returns to lenders Returns to platform investors
Deposits Deposits processing costs Operating expenses attributed to lenders
Source: Deloitte analysis
12Marketplace lending |
A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
To look at this another way, consider
that banks are able to borrow very
a significant proportion of their balance
sheets by taking current-account deposits For these reasons,
cheaply – taking deposits gives them
inexpensive access to funding. This is a
that are inherently less sensitive to changes
in base rates than other sources of funding, we believe that banks
structural benefit enabled both by their
unique regulatory position (with deposits
such as term deposits (see Figure 9). For
these reasons, we believe that banks will will have a structural
underwritten by the protection scheme/
government) and by their ownership of
have a structural cost advantage over
MPLs if and when the credit environment cost advantage over
the payments infrastructure. Banks fund normalises.
MPLs if and when the
credit environment
Figure 9. Bank deposit interest rates in a normal credit environment, percentages
normalises.
8%
7%
6%
5%
4%
3%
2%
1%
0%
1-Jan-07
1-Jan-95
1-Sep-02
1-Jan-03
1-May-03
1-Sep-03
1-Jan-04
1-May-04
1-Sep-04
1-Jan-05
1-May-05
1-Sep-05
1-Jan-06
1-May-06
1-Sep-06
1-May-07
1-Sep-07
1-May-95
1-Sep-95
1-Jan-96
1-May-96
1-Sep-96
1-Jan-97
1-May-97
1-Sep-97
1-Jan-98
1-May-98
1-Sep-98
1-Jan-99
1-May-99
1-Sep-99
1-Jan-00
1-May-00
1-Sep-00
1-Jan-01
1-May-01
1-Sep-01
1-Jan-02
1-May-02
Base rate Term deposits Instant access deposits Current accounts
Source: Bank of England, Deloitte analysis
Operating expenses Figure 10. Operating expenses of an unsecured personal loan, banks and MPLs
In this section, we compare the operating
Unsecured personal loan, % of loan amount (bps)
costs incurred by banks and MPLs by
examining the structural advantages for
215 bps
each model in making and servicing loans
(considering the operating costs associated 180 bps
50 bps
with lending activities alone).35
40 bps
45 bps
115 bps
95 bps
50 bps
Bank MPL
Loan acquisition costs Loan processing and servicing costs Loan collections and recovery costs
Source: Deloitte analysis
13Marketplace lending | A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
Customer awareness of marketplace One in 25 retail consumers who are aware MPLs are now aiming to leverage these
lenders in the UK of MPLs, meanwhile, has borrowed from high awareness figures to improve their
According to the survey we commissioned one. Similarly, one in 20 retail consumers conversion rates. One way of achieving
as part of this research, there is a who are aware of MPLs has lent through this is to form industry bodies to educate
reasonable awareness of MPLs among one (see Figure 11). consumers. UK MPLs have formed the
retail consumers and SMEs in Britain. Just P2PFA, representing the majority of the
over half of consumers and three-quarters Among SMEs, one in 25 that are aware of UK MPL market across all segments,36 to
of SMEs are aware of MPLs. MPLs has borrowed from an MPL and around promote their nascent industry.
one in 30 that have heard of MPLs has lent
through such a platform (see Figure 12).
Figure 11. Awareness and usage of MPLs, retail consumers
Aware? Aware of specific MPLs? Used?
53% 4%
aware borrowed
53%
aware
5%
lent
MPLs
47%
not aware
91%
not used
47%
not aware
Source: YouGov plc 2016 © All rights reserved, Deloitte analysis
Base: All GB adults (nationally representative), 2,090
See appendix for survey questions
14Marketplace lending |
A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
Figure 12. Awareness and usage of MPLs, SMEs
Aware? Aware of specific MPLs? Used?
76% 4%
aware borrowed
61%
aware
3%
lent
MPLs
39%
not aware
94%
not used
24%
not aware
Source: YouGov plc 2016 © All rights reserved, Deloitte analysis
Base: All SME senior decision makers (nationally representative), 1,609
See appendix for survey questions
MPLs have used a wide variety of marketing methods to drive awareness. As MPLs are innovative, digital platforms, it is interesting to
note that traditional media (TV and radio advertising in particular) represent by far the greatest source of awareness. And while early
growth in the industry is often attributed to word-of-mouth, such recommendations are not a key source of awareness at this stage
(see Figure 13).
Figure 13. Sources of awareness of MPLs, retail consumers
Traditional media
Traditional media 29% 17% 10% 4% 60% Television or radio advertising
Magazine/newspaper article
Television or radio programme
Digital media 11% 8% 7% 26% (not including advertising)
Print advertising
Recommendation 5% 3% 8% Digital media
Online advertising
Don't know (excluding social media)
/can’t recall 16% Social media
Online blog
Other 9%
Recommendation
Recommendation from
a friend/colleague
Recommendation from
a financial advisor/bank
Source: YouGov plc 2016 © All rights reserved, Deloitte analysis
Base: All GB adults aware of one or more of the above peer-to-peer lenders (nationally representative), 588
See appendix for survey questions
15Marketplace lending | A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
Acquisition Such search terms, in fact, make up 11 Processing/servicing
Unlike MPLs, banks tend to have large of the top 20 most expensive Google Unlike in the customer-acquisition area,
existing customer bases and the ability AdWords in the UK.39 As MPLs seek to MPLs have a potential advantage in
to drive awareness via above-the-line compete both with the banks and with one processing/servicing thanks to their ability
advertising across a wide product portfolio. another in mainstream lending, it therefore to design from scratch purely online
While it seems likely that these attributes appears likely that search engines or price- channels to handle the loans on-boarding
give them a material advantage in comparison sites will end up with much of and servicing processes.
acquiring new personal and SME loans, our the value.
research in this area suggests that MPLs A fully automated process for processing
already have a surprisingly good level of The other analogy is with the credit card and underwriting loans allows MPLs to
awareness: one in two retail consumers (53 market, where over the last 25 years or avoid the material costs that banks have to
per cent) and three in four SMEs (76 per so banks have faced intense competition deal with as a result of their legacy systems
cent) are aware that they exist37 (see the from non-bank monolines seeking to break and multiple channels. This also holds true
‘customer awareness’ box). Conversion is the relationship between the primary for servicing where a surprising number
currently relatively low: only one in 25 retail current account and credit products. While of banks have, for example, no automated
consumers who are aware of MPLs has these credit specialists have had some scoring systems for SME overdrafts –
actually borrowed from one. However, the success, even after this period of sustained this results in a significant proportion of
ability of MPLs to spread their message via competition around a third of active relationship managers’ time being taken up
new digital channels, to use their speedy credit card holders in the UK still have a in renewing overdrafts.
processes to encourage purchase, and current account with the same bank that
to leverage their structurally-advantaged issued their card.40 The task facing MPLs As highly regulated entities, banks also
risk appetite (see ‘credit risk’ below) points is therefore significant, particularly given incur significant costs, both in ensuring
to the potential they have to negate the that the relationship between the primary compliance and in redressing any breaches.
banks’ advantages. Two analogies, however, current account and loans is even tighter. For the time being at least, MPLs can avoid
provide a counterpoint to this optimistic (For example, almost 90 per cent of SME much of this burden (see the ‘Regulation –
view of MPL’s acquisition costs. loans are extended to existing holders of friend or foe?’ box on page 18).
business current accounts.) 41
The first is the escalation of acquisition
costs among online price-comparison sites
in the UK. Here, a marketing ‘arms race’ has
pushed above-the-line advertising spend
to a remarkable level, with the largest four
UK price comparison sites spending more
than £100 million a year.38 Similarly, the
competition among these sites has pushed
the price of financial services-related
keywords to levels where loans sourced
through these channels are believed to be
breakeven at best.
163. The relative economics of marketplace lenders vs banks
17Marketplace lending | A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
Regulation – friend or foe? •• dispute resolution rules – investors have 1. Investor funds are not guaranteed
Before 2013, MPLs were subject to little the right to complain, firstly to the MPL MPL investors do not have access to the
or no regulation, with none at all being and, if the dispute remains unresolved, to Financial Services Compensation Scheme
tailored to the MPL model. The UK Financial the Financial Ombudsman Service. (FSCS), which protects the first £75,000 of
Conduct Authority (FCA) had the stated “The rules for dispute resolution do not deposits; this is because the money lent is
aim of providing “adequate consumer mandate specific processes, so long not classified as a ‘deposit’.
protections that do not create too many as complaints are dealt with fairly and
barriers to entry or significant regulatory promptly”45 Second, some MPL platforms have
burdens for firms”.42 The FCA operates established their own ‘provision funds’ to
a disclosure-based regime, designed help investors recover lost monies in the
•• if an MPL goes out of business, it must
to advance its objectives of supporting event of borrower default. However, no
take “reasonable steps … to ensure loan
effective competition and an appropriate MPL platform guarantees that a provision
agreements facilitated on the platform
degree of protection for consumers. fund will make investors ‘whole’ (enable
will continue to be managed and
them to receive all their money) after
administered with the contract terms, if
The current FCA MPL regulation consists of: borrowers have defaulted. There is a risk
the firm ceases to carry on the regulated
that investors will misunderstand such
•• capital requirements – before 1 April activity in relation to lending”46
funds as a guarantee that their investment
2017, marketplace lenders with FCA
is safe, when their role is simply to mitigate
authorisation must hold the following in
•• conduct – MPLs must “ensure that possible losses.
regulatory capital:
investors have the information they need
–– a minimum of £20,000 to be able to make informed investment 2. Liquidity risk
decisions and that all communications Investors on MPL platforms may not realise
–– 0.2 per cent of the first £50 million of
are fair, clear and not misleading.”47 (For that they are usually ‘locked in’ to their
total loans outstanding, 0.15 per cent
further information, see conduct risk investments until they mature. (While some
of the next £200 million, 0.1 per cent of
section below.) MPLs have a secondary market in which
the next £250 million, 0.05 per cent of
investors can cash in their investments
the remaining balance.
Conduct risk before maturity, such markets are currently
The FCA has defined conduct risk as “the underdeveloped.)
This will increase from 1 April 2017 to
risk that firm behaviour will result in poor
whichever is the higher of:
outcomes for customers.”48
–– a minimum of £50,000
The FCA expects MPLs to manage conduct
–– 0.3 per cent of the first £50 million, risk by looking at their business models
0.2 per cent of the next £450 million, and strategic plans to ensure that they are
and 0.1 per cent of all money lent above identifying, mitigating and monitoring all
£500 million.43 the risks to consumers arising from them.
The FCA is clear that all firms, including
•• client money protection rules – MPLs
MPLs, need to accord equal significance
holding client money are subject to Client
to customer outcomes as to commercial
Assets Sourcebook (CASS) rules requiring
objectives.
firms “to ensure adequate protection of
client money when the firm is responsible
Deloitte believes that five key conduct risk
for it”44
considerations relate equally to lenders/
investors and borrowers:
18Marketplace lending |
A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
3. Investor understanding 4. Credit risk and the potential for UK regulation – outlook
Deloitte’s consumer survey shows that financial loss MPLs have a favourable view of the
the general population has a good Most MPLs assign a credit risk score or current size and scope of regulation.
understanding of the risks involved particular pricing to a loan. Investors face They believe the regulation is not overly
in lending through MPLs. However, a the risk that such scoring is inaccurate or onerous, particularly in terms of capital
significant minority (see Figure 14) believes that such pricing does not truly reflect the requirements, allowing them to maintain
that savings accounts and government credit risk exposure. one of their key competitive advantages
bonds are riskier than investing through over banks. This light-touch regime also
MPLs. 5. Treatment of borrowers allows MPLs to concentrate on growth
Borrowers participating in marketplace and innovation rather than regulatory
This suggests that the industry has lending are also exposed to conduct risks, compliance.
not yet attained the levels of customer which principally include loan affordability,
understanding that the FCA is looking for. treatment of customers in financial However, as MPLs grow and become
difficulty and clarity of information before, more important to the financial system,
Firms that fail to comply with the during and after the point of sale. they are likely to become more tightly
FCA’s disclosure regime are at risk of regulated, with higher capital-adequacy
enforcement action by the FCA, but this is a ratios, limitations to business models and
punitive tool after the event, rather than more prescriptive disclosure requirements.
a preventative one. This could erode the favourable regulatory
arbitrage MPLs currently have over banks,
and cause them to refocus their efforts less
single-mindedly on growth and innovation.
Figure 14. Risk of lending through an MPL platform compared to other savings/investment options, retail consumers
Savings account 63% 8% 10% 19%
Government bonds 54% 11% 9% 26%
Corporate bonds 40% 18% 9% 34%
Stocks 34% 25% 19% 22%
Other securities
27% 23% 13% 36%
(e.g. futures, options)
MPLs are more risky About the same MPLs are less risky Don’t know
Source: YouGov plc 2016 © All rights reserved, Deloitte analysis
Base: All GB adults aware of peer-to-peer lenders (nationally representative), 1,168
See appendix for survey questions
Approximately one in five retail consumers believes lending through MPLs is as risky or less risky than savings account or
government bonds
19Marketplace lending | A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
There are questions over the sustainability
of MPLs’ advantage in the area of
Credit risk
Overall, our research gives us limited Overall, our
operating costs. Banks do appear to be
disadvantaged for the time being, however,
grounds to believe that MPLs will
systematically price risk better in areas research gives us
and their ability to address this in the near
future is hamstrung by a series of factors,
where banks have an appetite to play.
limited grounds to
which also constrain their ability to improve
customer experience. Factors include:
Supporters of MPLs point to a number
of potential areas of advantage over the believe that MPLs
•• their ability to attract the right talent
traditional bank model, including:
will systematically
•• their ability to prioritise investment in an
•• a willingness (in part born of necessity)
to experiment with a wider set of data price risk better in
environment that is still dominated by
post-crisis regulatory change
sources for risk scoring
areas where banks
•• an understandably cautious culture.
•• a more agile approach to developing and
evolving a more agile core risk-scoring have an appetite
Collections and recoveries
algorithm.
to play.
Our research suggests that at maturity, As further evidence that innovative
when MPLs’ loan portfolios are likely to approaches are working and will improve
more closely resemble those of the market over time, these supporters also point to
as a whole, MPLs will have no material the current quoted loss rates of MPLs,
source of cost advantage over banks which look no worse than typical bank loss
relating to collections and recoveries. rates (see Figure 15). However, the majority
And while MPLs may pass the costs of of UK MPLs are yet to go through a credit
collections and recoveries on to lenders, cycle, and it therefore remains to be seen if
this will over time simply increase the there will be an increase in default rates in
required return and the cost of funds. the event of an economic downturn.
Figure 15. MPL default rates, 2010-2015*
6%
5%
4%
3%
2%
1%
0%
2010 2011 2012 2013 2014 2015E
Funding Circle RateSetter Zopa MarketInvoice Sector average
Source: MPL websites, Deloitte analysis
*2015 figures are estimated default rates from MPL websites
20Marketplace lending |
A temporary phenomenon?
3. The relative economics of marketplace lenders vs banks
However, while some of the risk
professionals and other market
Relative economics of MPLs vs banks:
our conclusion Our analysis
participants we interviewed acknowledged
that a better risk-scoring algorithm might
Our analysis shows that banks have a
structural cost advantage over MPLs. shows that banks
be developed outside the banking system,
all cautioned that it is too early to tell
While MPLs may enjoy slightly lower
operating costs, a bank’s broad cost have a structural
whether or not this has happened. And,
if it is does happen, the consensus was
profile is less sensitive to changing interest
rates than that of an equivalent MPL. This cost advantage
that this was unlikely to be the result of a
systematic advantage of the MPL model;
advantage is not particularly evident in
the current credit environment, with rates over MPLs.
rather, it would be a specific, model- at historically low levels. However, if and
agnostic, innovation. In other words, when the credit environment normalises
banks could exploit the same algorithmic and rates and spreads return to pre-crisis
innovations. All also commented on the levels, we expect that the costs incurred
fact that, in the short-term at least, MPLs in MPL credit transmission will increase by
cannot replicate banks’ core advantage more than those of bank lending.
of having access to customers’ historical
transactional data. For these reasons, we do not believe that
MPLs pose a disruptive threat to banks
That said, provided that loans behave in terms of relative economics. Banks
broadly as predicted over time, the ability currently have a pricing parity with MPLs;
to use the brokerage model to match this will become a pricing advantage in
borrowers and lenders by risk appetite, a normalised interest rate environment.
coupled with the diversification achieved by Our market-sizing assessment, therefore,
pooling invested money and lending it out does not foresee a shift in lending from
to several borrowers, does seem likely to banks to MPLs owing to a structural pricing
support an inherently wider risk appetite. advantage.
In turn, the resulting wider coverage of
businesses or individuals eligible for loans For MPLs to be a disruptive threat, they
may potentially deliver higher acceptance would need to achieve at least one of the
rates and so reduce the effective cost of following:
customer acquisition.
•• offer a superior customer experience,
potentially by expanding their offering
to include ancillary services such as
cashflow tools and business advice, for
which customers would be willing to pay
a premium
•• undermine banks’ funding advantage by
drawing funds away from deposits into
marketplace lending.
21Marketplace lending | A temporary phenomenon? MPLs have been able to differentiate themselves by offering an attractive customer experience. 22
Marketplace lending |
A temporary phenomenon?
4. The user experience of marketplace lenders vs banks
4. T
he user experience of marketplace
lenders vs banks
As part of our research, Deloitte conducted a YouGov survey of retail consumers and SMEs. The results provide strong evidence
that MPLs have been able to differentiate themselves by offering an attractive customer experience at acceptable lending rates
(see Figure 16 below).49
Figure 16. Drivers behind usage of MPLs to borrow money, retail consumers
Easy/quick application process 81%
Fast decision-making 72%
Convenience of online platform 72%
Competitive rates 69%
Repayment flexibility 55%
Little documentation required 53%
Trying out a new way of borrowing 39%
Less personal data required 35%
Couldn't get a loan/credit elsewhere 30%
Recommendation from friend/colleague 22%
Distrust of banks 18%
Recommendation from banker/financial advisor 12%
Source: YouGov plc 2016 © All rights reserved, Deloitte analysis
Base: All GB adults who have borrowed via a peer-to-peer lending platform (non-nationally representative), 89
See appendix for survey questions
This is backed up by the views expressed 2. if banks choose to flex the pricing •• a relatively risk-averse approach to
by the UK MPLs, banks and investment advantage we believe they have, how innovation
managers we interviewed as part of the many customers will be willing to trade
research. According to our interviewees, UX against price? •• a limited appetite for investment,
borrowers are primarily drawn to MPLs particularly given the competing claims
due to: It is clear that replicating this experience, or on such funds.
even substantially closing the gap, requires
•• the certainty of outcome for a loan more than just overlaying a slick digital As a result, Deloitte believes that this
application enabled by a fast decision- interface onto existing processes. non‑cost advantage is likely to endure for
making process some time.
It ultimately requires taking a far more
•• the small amount of documentation that customer-centric approach to product Turning to the second question, our work
borrowers need to provide as part of a and proposition innovation, accordingly in the sector suggests that while there are
loan application. re-engineering and automating processes cases where time is critical, a customer’s
deep in the bank’s operating model. willingness to trade off UX against rate
These advantages largely arise from MPLs’ Deloitte’s work with major institutions trying ultimately (and unsurprisingly) tends to
customer-driven focus on user experience to do this has given us a healthy respect for correlate with the absolute difference in
(UX) as a source of differentiation. Two just how hard it is for most banks to achieve interest cost between the two alternatives.
questions arise: this level of change. In our experience, a We have reflected this in arriving at our
number of factors may prevent banks from assessment of where and to what extent
1. ow sustainable is this UX advantage?
h quickly doing so, including: MPLs will win in the market.
(Surely banks can easily copy user
journeys that are seen to work and •• cultural and capability limitations
then leverage their broader customer
relationships and data to deliver a •• the current regulatory environment
distinctive experience that trumps
what MPLs have to offer?)
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