Neil Tomlinson, head of banking at accountancy firm Deloitte, explains why banks need to partner with peer-to-peer (or marketplace) lenders in order to compete effectively…
In Deloitte’s report “Marketplace lending – a temporary phenomenon?”, we examined whether marketplace lenders (MPLs) truly represent a disruptive threat to UK banks in the lending space. In our research, we explored some of the principal sources of competitive advantages for MPLs in the UK and some of the strongest headwinds facing them.
As part of our research, we conducted consumer and SME surveys to test our hypothesis that to be truly disruptive, MPLs would need to possess competitive advantages that create real customer value for both borrowers and lenders. The results provide strong evidence that MPLs have been able to differentiate themselves by offering an attractive customer experience at acceptable lending rates.
Borrowers are primarily drawn to MPLs due to the certainty of outcome for a loan application, enabled by a fast decision-making process, as well as the small amount of documentation required. Flexible lending metrics, across the board but particularly for SMEs, and a greater transparency as to what lender funds are being used for, help to cement MPLs’ customer experience advantage.
Such advantages largely arise from platforms’ focus on user experience (UX) as a source of differentiation from the outset. This is a more holistic approach than just digitally refurbishing a version of today.
Furthermore, MPLs’ brokerage-like structure, wider risk appetite and the diversification achieved by the ability to pool money invested and lend it out to several borrowers also gives them a competitive advantage. These attributes help to widen the coverage of businesses or individuals eligible for loans, therefore increasing the acceptance rate, enabled by the matching of high-risk borrowers with yield-seeking investors and low-risk borrowers with risk-averse investors.
One of the advantages most commonly pointed out by advocates of MPLs is their lower operating expenses, allowing MPLs to provide loans more cheaply than incumbents can. As part of our research, we developed a UK ‘MPL opportunity-assessment model’ to compare the lending costs of banks and MPLs. This allowed us to compare the costs incurred in originating and servicing through the traditional bank model with an equivalent loan originated and serviced through an MPL.
On the one hand, our research indicates that the operating costs incurred per loan by MPLs are slightly lower than those incurred by banks, particularly processing and servicing costs. However, our analysis also shows that the funding costs for a bank loan are likely to be lower than the equivalent costs for an MPL loan. While this currently gives banks a pricing parity with MPLs, we believe banks will have a pricing advantage in a normalised interest rate environment as funding costs account for a greater proportion of the costs of an MPL loan than those of a bank loan.
Moreover, as the MPL model is high-volume low-margin, turning a profit in this business requires scale. Platforms therefore need to attract a large number of borrowers to be viable. However, our consumer and SME surveys demonstrate that while marketplace lenders enjoy a high level of awareness, they struggle to convert awareness into usage. Both individual and SME borrowers are deterred by unfamiliarity, security concerns, distrust and a lack of prior relationship. MPLs will have to address these concerns if they are to achieve the scale they need.
We believe that attracting funds at a sufficiently low rate for their borrowers may prove to be a significant headwind for MPLs in the UK. Furthermore, this headwind will be exacerbated when interest rates normalise. Deloitte’s view is that in the short to medium term, MPLs are likely to have a window of opportunity if interest rates remain “lower for longer” (which, in the UK, seems even more likely to be the case in the wake of the EU referendum) and if banks are unable or unwilling to replicate MPLs’ much vaunted customer experience.
However, our findings suggest that MPLs in the UK are unlikely to pose a threat to banks in the mass market in the long term. As such, we do not believe that the banking model in the UK will be fully disrupted by MPLs. We therefore believe that banks can, and should, evaluate a wide range of options for enhancing their overall customer proposition by partnering with MPLs.