Online P2P lending began in 2005 with the launch of Zopa in the UK. Back then, “niche” or “ephemeral” at best, if not “shady”, have been some of the most eagerly used words to describe the baby sector. Fifteen years on, people lend and borrow billions of dollars on hundreds of P2P platforms across the globe. “Innovative”, “disrupting”, “game-changing” is all you can hear today. How has this unprecedented P2P lending boom come around? And, is P2P lending all that new in the first place?
The Pre-History of P2P Lending
It shouldn’t come as a surprise that people had borrowed money from one another before 2005. Indeed, the 20th century was largely a blind spot for a more “structured” peer-to-peer lending – the expansion of banking services led to banks’ effective monopoly in financial intermediation. It’s not bad at all – banking services were convenient, easily accessible and safe – good job, Wall Street! But how then people had lent and acquired capital before the banks came around?
The simple answer is they had lent to and borrowed from one another. For example, one account of peer-to-peer lending schemes in 18th century France tells us that there indeed existed local non-notarised credit markets way before the banks came around. These markets functioned typically in hermetic circles where people living in close neighbourhoods (e.g. a village) exchanged both money in cash and goods in the form of deferred payments. They used the debts both to smooth consumption and palliate the lack of cash, but also to make investments (e.g. buy livestock). In those rather dense networks, people exchanged capital not only with one another but were also connected to several individuals at a time, which helped increase the information flow, facilitate the matching process, and maximise the capital allocation – sounds familiar?
Such schemes were prevalent across Europe, along with many other “alternative finance” solutions, as we’d call them today, which were probably even more widespread. From German credit cooperatives to Irish loan funds, first initiated by Jonathan Swift – the author of Gulliver’s Travels, early industrial Europe was crowded with peer-based finance and crowdfunding schemes.
Of course, the scale of the exchange back then was rather limited, compared to today’s global networks of lenders and borrowers. People most likely personally knew the other party, and keeping track of the investments and obligations was limited to running a simple account book or, if you happened to be an illiterate peasant, even archiving each transaction in bundles in wooden boxes (an equivalent of your favourite P2P platform’s feed).
P2P Lending 2.0
Even though it seems like a whole different world, the principles behind modern P2P lending are exactly the same. A look into the early origins of the pioneer – Zopa, surely helps understand the emergence of the modern, online, P2P lending. David Nicholson – the co-founder and mastermind of Zopa, reveals that his inspiration came from understanding the pre-banking past and the basic principles of lender-borrower relationship, rather than letting his mind travel to the sci-fi-like future of finance, as one might think:
“I sort of was building a deeper understanding of what’s really going on here, and what’s really going on in a bank and sort of reading a little bit about where banks came from and how banking has moved over the years and actually understanding that really, although a lot of stuff looks very complex, there’s actually some pretty simple basic building blocks underneath. Then, if you go back and look at those building blocks, you understand why banks have been the institutions that have been capable of doing those because, you wind back 100 or 200 years, you didn’t have any of the information, or the systems, or the technology, that would enable anybody else to do that intermediary function.”
David Nicholson, quoted in Peer-to-peer lending and financial innovation in the United Kingdom, Bank of England, 2016, available here.
Nicholson and his colleagues were successful in pitching the idea and raising funds to launch Zopa in 2005. A year later, Lending Club and Prosper – two of the most prominent P2P lending platforms to this day, launched in the US. But the business seemed to be, at the start, just like the critics named it – “niche” and “shady”. Nicholson describes the early years of Zopa as “very, very tough” as there were few interested lenders and many un-creditworthy would-be borrowers.
The real turning point for the sector came with the financial crisis of 2008-09. Public confidence in financial institutions collapsed. So did the credit supply as many banks run into serious survival issues. Quite suddenly, large numbers of individuals and businesses found themselves unable to secure a loan, small and medium enterprises (SMEs) facing particular difficulties. At the same, investors were turning away from conventional banking products and increasingly looking for alternative solutions that could yield higher returns.
Many of both the loan-seekers and adventurous investors landed on P2P platforms. Zopa saw a spike in numbers of lenders willing to take the risk and the pool of more creditworthy potential borrowers widened as well. The newfound success of the first platforms triggered a wave of new entries. Rate Setter – one of the most popular UK platforms, and Funding Circle – the world’s first P2P platform to focus on funding business loans, both launched in 2010. Hundreds of others followed.
The Spread of P2P Lending
The pioneer (the UK) and its first, quick follower (the US) have benefited significantly from the first-mover advantage and dominate the P2P lending markets to this day. In 2018, they held 57% and 96% of market share in alternative finance in Europe and North America respectively. However, continental Europe is catching up quickly, likely encouraged by the new EU regulation proposals and the similar constraints in the banking credit field (the market share of UK-based platforms was 68% just the previous year). In particular, small, open and innovation-driven Nordic and Baltic states show impressive growth rates and some of the highest per capita volumes in the world.
Even more impressive is the growth of P2P lending in the developing world. According to the Global Alternative Finance Market Benchmarking Report, year-to-year market volume growth between 2017 and 2018 varied from 102% in Africa to 131% in the Middle East to 173% in Latin America to astounding 574% in South East Asia!
There is another side of this phenomenal diffusion of P2P lending though. China has quickly become by far the world’s largest P2P lending market, even though it joined the race quite late (around 2012). However, after the rapid rise, China’s P2P lending industry has experienced an even more dramatic fall, shrinking by almost 40% between 2017 and 2018 due to the new government regulations curbing the once-booming sector.
The Future of P2P Lending
Over the (not so many) years, the P2P lending sector has not only spread across the world’s markets but also evolved in and of itself. There are several trends and lessons learnt that we can draw from the development of the P2P lending sector so far:
The sector is diversifying. Starting from a simple individual borrower-platform-individual lender relationship, different P2P business models have emerged and there is an increasing number of platforms that specialise in certain types of loans (invoice trading, property lending, balance sheet business lending, and so on).
Institutional investors are increasingly making use of P2P lending to support their own investment strategies. On average, around 50% of P2P loans worldwide are now funded by institutional investors such as banks, pension funds, trusts, brokerage firms, investment dealers or insurance companies (although in the US, the rate goes up to as much as 85%).
Business lending is already the dominant segment and is projected to garner an even more significant share of the total P2P lending market in the near future. SMEs face particularly high barriers in accessing bank credit and thus, they increasingly turn to alternative finance solutions to fuel their business growth.
It’s all about the right regulation. The case of China shows explicitly how disastrous lack of regulation can be (from platforms’ liquidity crises and shutdowns to the spread of pyramid-scheme scandals during the boom years of the Chinese P2P market). At the same time, it proves that a harsh regulatory crackdown can not only alleviate all these problems but also effectively destroy the whole sector.
Overall, from being “niche”, “shady” and very much outside the financial system, P2P lending is inevitably becoming an intrinsic part of it. While institutional investors already fuel the supply of P2P loans, policymakers either work to create new regulatory frameworks for the new sector (see the above-mentioned EU crowdfunding regulation) or include the platforms in the existing mechanisms (e.g. in the UK, P2P platforms are regulated by the Financial Conduct Authority). The British regulators have even included top P2P platforms in the Coronavirus Business Interruption Loan Scheme (CBILS), recognising the crucial role they play in channelling funds to SMEs. In this respect, at least in the UK, the COVID crisis seems to be another stepping stone for the P2P lending sector (P2P lending likes crises it would seem).