As participants in peer-to-peer lending markets, we are often asked to comment on the “institutionalization” of the markets. The insinuation behind the question is that involvement from “wall street firms” has ruined the peer-to-peer lending concept in its infancy.
I can’t help but think about the Shawshank Redemption every time the question comes up. As Red, imprisoned for life, explains from behind the walls of the prision – “These walls are funny. First you hate ’em, then you get used to ’em. After long enough, you get so you depend on ’em. That’s ‘institutionalized.’” Obviously he isn’t theorizing on investing, but his meaning is clear – institutions can eventually force you to give in to their will and there is little that can be done to stop them. That sounds terrible – but is that really what is happening in peer-to-peer markets?
The way I see it, the main role of peer-to-peer lenders is to free up capital. The parallel is often made to Uber or Airbnb, which is fair. Those institutions are taking capital that many people have (cars and homes) and allowing them to generate returns on that capital. Taking the example of debt-consolidation, peer-to-peer lenders are attacking brick-and-mortar banks by being lower cost and passing on the savings to borrowers. Fitch, in its peer-to-peer lending review last August, calculated that Lending Club starts with a 4.25% cost advantage over traditional banks. Being able to offer lower rates attracts the borrowers, as they get access to loans at a better rate than was previously available. Investors with idle cash can lend to those who need to borrow, accepting the risk that comes with consumer credit in exchange for a very competitive return profile.
Prior to peer-to-peer, it was very difficult for private investors to create a diverse portfolio of direct lending and nearly impossible for borrowers to lower their credit-card borrowing rates. The hope was to create credit flow in a market where banks were effectively pulling away. As Andy Dufresne, a man in prison for a crime he did not commit, tells us in Shawshank, “Hope is a good thing, maybe the best of things, and no good thing ever dies.”
Combining the lower cost and access to capital was like dropping a match in gasoline – boom – the peer-to-peer markets exploded and capital started to flow.
Here’s the rub. It was destined to die, as there are more borrowers than lenders. In other words, if peer-to-peer markets limited their investment base to single retail players, the entire experiment was bound to fail – or at least be relegated to insignificance in the $850+bn consumer credit markets.
This begs the question, “Is there a big pool of capital that is starved for yield from a unique source?” With ten-year treasuries near 2% and ten-year German Bunds near 0.30%, the answer is a resounding ‘yes.’ Smart, fast moving pools of capital noticed and started to invest. This is where I think the “institutionalized” claim is bogus. These aren’t the vast, immovable walls of Shawshank prison. This is money from pension funds, endowments, family offices, investment advisors – all aggregators of the retail money peer-to-peer platforms so highly covet. I’d argue that what we have here is the beginning of a marketplace. Individual investors with capital are free to try and navigate the ever-changing world of consumer credit. We’ve spoken to over 70 different peer-to-peer lenders since our inception in 2013 – so it is something more easily said than done. Institutions are free to look at peer-to-peer as an emerging asset class. The truth is, it is still too small for the larger institutions to use effectively. For a firm such as Blue Elephant, there is an amazing opportunity to build a diverse book of loans across geographies and lending types, so long as we can attract interested capital.
All of these different investors will move in and out of peer-to-peer just as they do other investments. This is healthy – we are in the early stages of a real market.
Andy Dufresne escapes the walls of Shawshank prison by tunneling through them little by little with a rock hammer. “I remember thinking it would take a man six hundred years to tunnel through the wall with it. Andy did it in less than 20.” With some help from all different players, institutions included, maybe we’ll have more rapid success bringing peer-to-peer from infancy to major player in the credit markets. We always have hope, anyway.