The disruptive potential of P2P financing

For centuries, banks played a central role in the financial services ecosystem by acting as intermediaries between fund originators and fund consumers. Be it transfer of money between two participants or lending or borrowing, banks were the only source connecting the various entities. In the process, they made profits by managing the spread between lending and borrowing rates.

However, the advent of technological innovation has changed the scenario drastically enabling a new set of players — fintechs — to deliver financial services effectively.

However, this disruption has not changed the fundamental principles of payments and lending. It has brought about a transformation by enabling disintermediation and aggregation, the former by directly connecting the lender and the borrower and the latter by bringing together groups of lenders and borrowers on the same platform. By providing a level playing field, it has enabled participants to interact and collaborate to achieve their objectives. Borrower and lender determine the marketplace and not the financial institution.

By moving away from the traditional bank account or the network of the payment provider as the mode, to an array of identifiers for them — mobile, wallet or unique identifier code — fintechs have removed the centrality of the financial provider. An identifier is enough to move funds across players. This potential for a win-win situation across entities in the financial ecosystem driven by the entities themselves and accelerated by a sound technology platform, has been the fundamental force driving P2P (peer to peer) initiatives.

P2P is an important change for banking institutions as commerce is beginning to move beyond the conventional merchant relationship to a broader peer-to-peer exchange. The potential of lending and payments related transactions through P2P are substantial. For instance, some estimates peg the consumer credit market share at $3.2 trillion. Banks are exploring retention or enhancement of their share in this space through an appropriate partnership — with the right platform(s) and bringing the best practices on to that. On the one hand, they use fintechs to enable their customers to lend or borrow, and on the other they act as a customer by making a fee while retaining their customer. Fintechs also stand to benefit by getting access to leads and a larger community. It has also given banks an ability to compete against money transfer firms.

With P2P falling under a para-banking set-up, it is not viewed favourably by governments and regulators. The P2P models are subject to multiple risks both on the credit and liquidity side and regulators have been slow in recognising this trend and providing steps to mitigate such risks. Legal risk components begin with the regulators themselves not being clear about the category under which new financial instruments fall.

However, regulators are encouraging banks to align with these platform providers in the hope that fintechs become only platform providers, thereby ensuring their ambit is not extended to such organisations. Further, the banks that tie up with fintechs also bring in their practices in terms of legal coverage and dispute resolution. It is an encouraging trend. As long as fintechs remain outside regulation, the normal protection available to borrowers or lenders in the current regulation will not be applicable.

A few lines of products in the retail space such as personal lending, mortgage lending and other forms of unsecured credit including credit card lending are potentials that would move the fintech way. Given the fact that peer-to-peer loan volume is expected to hit $77 billion in 2015, there’s a very high likelihood that the mortgage loan footprint of P2P loan providers will grow. As more and more P2P providers compete for mortgage customers, this new type of loan is probably worth looking into in order to compare it with other, more conventional, loan sources. There will be a churn of the P2P platforms based on the nature and range of partnership with the regulated institutions. Independent ones might not be able to survive. As platforms evolve and gather more momentum, the components that are available in the current systems for fraud, credit rating and risk management would also be added. Further, banks are likely to seek partnership with not just P2P platforms but banking aggregators, insurance aggregators and digital wallet providers. Although this may not ensure any protection to customers against credit risk, the fact that their banks refer select platforms does provide credibility. There is also less chance of partnering platforms going bankrupt as it is in the bank’s interest to ensure the risk is low.

The P2P phenomenon has sparked both interest and controversy in recent years. There is every sign that fintechs would eat into the regulated institutions’ share in lending and payments; the latter including money transfer entities as well. The central role played by financial institutions is on a decline. Given the market potential estimates both from lending and payments perspective, it might be in the interest of banks to enter into partnership with fintechs to create synergies and realise benefits.

The writer is the director, product division, of Maveric Systems

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