A perfect storm
In the wake of the global financial crisis, UK banks pulled back from lending, owing to higher regulatory capital requirements and greater regulatory and shareholder scrutiny of their business models. They have adopted more risk-averse lending strategies in this environment, with more stringent reviews of the creditworthiness of borrowers.
Furthermore, the low-interest rate environment brought about by the global financial crisis has made it challenging for savers and investors to generate satisfactory returns. This has led investors to explore other investment options in a quest for yield.
These factors have created the conditions for the marketplace lending model to gain traction in the UK.
From P2P to MPL
This was initially facilitated by platforms enabling retail borrowers and investors to contact each other directly, or 'peer-to-peer' (P2P). More recently, institutions have begun to invest in bundles of loans, prompting the sector to be described more accurately as 'marketplace lending.'
Unlike banks, which take in deposits and lend to consumers and businesses, MPLs do not do not take deposits or lend themselves, and therefore are not taking risk onto their own balance sheets. They instead generate income from fees and commissions received from borrowers and lenders, rather than receiving interest income from borrowers directly.
Marketplace lenders have experienced strong growth, with a compound annual growth rate (CAGR) of 109.4 per cent between 2010 and 2015 in the UK.i However, despite strong growth, MPLs currently account for just a small proportion of the total consumer and small and medium-sized enterprise (SME) lending market in the UK.
Up to now, growth has been mainly driven by external factors. The UK government seeks to encourage competition in financial services, and the development of fintech in particular. Historic low interest rates have also stimulated a search for yield that regular deposit accounts cannot satisfy. Both borrowers and lenders are also increasingly drawn to the intrinsic qualities of the MPL model. Borrowers are attracted to the customer experience, while lenders appreciate access to a new asset class.
In terms of business model, MPLs benefit from innovative technology that enables highly efficient acquisition, approval and servicing of loans. By contrast, most banks' operating profiles include legacy IT expenses and significant regulatory overheads.
MPLs have changed the narrative
Many commentators are now talking about the disruptive threat that marketplace lenders create for banks in the UK. Lending is one of the core profit-generating activities undertaken by retail banks. The net interest margin obtained as a result of managing spreads is the main source of income for a retail bank.
Lending is also strategically important. It cements the customer relationship, particularly in business banking, by:
- generating more data about the customer, so that products are better matched to customers and better priced, e.g. ensuring the rate charged adequately reflects the risk
- creating cross-selling opportunities
- generating stickiness e.g. prevent customer switching to another bank.
For these reasons, we decided to examine whether or not MPLs truly represent a disruptive threat to UK banks in the lending space in our report "Marketplace lending – a temporary phenomenon?"
More can be found in our report. Below is a list of eight things you might not know about marketplace lending in the UK.
Eight things you might not know about marketplace lending in the UK
- The world's first MPL was founded in the UK in 2005.
- Most platforms split money invested by lenders into smaller "tranches" and lend out to several borrowers.
- MPL-based consumer lending in the UK grew at 81.2 per cent a year between 2010 and 2015.
- SME lending (including invoice trading) via MPLs experienced even faster growth, growing at 6 per cent a year during the same period.ii
- The total number of active borrowers using UK MPL platforms almost doubled in 2015 alone.iii
- MPL investors do not have access to the Financial Services Compensation Scheme (FSCS), which protects the first £75,000 of deposits.
- Just over half of consumers and three-quarters of SMEs are aware of MPLs.iv
- Marketplace loan products are now eligible for investment in Individual Savings Accounts (ISAs) through the Innovative Finance ISA (IFISA), launched on 6th April 2016.v
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