Democratising credit markets with P2P loan financing
by Kimmo Rytkönen, CEO and co-founder of Income
A new investment type emerged around 2005 that began to challenge the credit monopoly of banks. Thanks to new innovative fintech start-ups such as Zopa, Prosper and Lending Club, a new type of investment form known as peer-to-peer (P2P) lending made it possible for retail investors to put their money in small loans that help consumers realise their financial needs and goals. At the time, small loans were generally uninteresting for investors and consumers had few opportunities to find financial partners other than their local banks. This changed with the emergence of new digital platforms that created opportunities for investors to offer their loans online and that removed the bank as an intermediary.
P2P lending today
The P2P concept refers to direct person-to-person interactions or transactions. A P2P loan is therefore a loan from one private person to another. The first generation of P2P loan financing platforms made it possible to directly match lenders looking for investment opportunities with borrowers seeking small consumer or business loans. Today’s second generation of P2P marketplaces added another actor to the platform known as loan originators (LO) that made investments safer and more convenient. LO are consumer credit companies that offer loans to borrowers outside a platform and then place them on the P2P platforms they cooperate with. Investors can acquire shares in these loans and the LO’s handle the credit and risk management. Often the LO’s also offer a buyback guarantee for loans which are late more than 60 days, reducing the investors´ exposure to bad debt.
Especially now, in times of zero or even negative interest rates, P2P loan financing has been one of the few options left for attractive investments. Investors typically earn about 10-12 percent yields per year. The P2P business model has therefore flourished in recent years and has become a multi-billion dollar industry. Global business P2P lending rose to more than $200bn in 2020 while global consumer P2P increased to more than $90bn. This rapid rise has been spurred by several factors, including the financial crisis of 2009 and the fast development of the platform economy in recent years.
Challenging the monopolies of banks
P2P lending made it possible to challenge the core business of traditional private banks. Banks manage customer deposits and lend them to other customers in the form of loans. By having insight into their customers’ everyday transactions, the banks used to have a de facto information monopoly, enabling them exclusively to vet borrowers and check their credit rating. Nowadays, with the increased availability of credit bureau and more experimental data points, the P2P marketplaces and other non-bank lenders are able to assess the creditworthiness of borrowers and thus mitigate credit risks of investors.
Income launches the third generation of P2P lending
The first two generations of P2P lending platforms have therefore brought lasting change to the credit industry, but there have also been some drawbacks. When the COVID-19 pandemic hit the global economy, many people lost their jobs, which put many borrowers under financial pressure and they unexpectedly defaulted. Consequently, some of the LO’s on P2P marketplaces got into trouble as well and P2P investors found themselves at a disadvantage due to insufficient security mechanisms. Also, many investors opted to withdraw their savings from the platforms, but often found it difficult to do so.
While the second generation of P2P revolutionised the credit market, the next generation will have to focus on making P2P lending more secure for all parties involved. Income, the new P2P marketplace is designed to launch the third generation of P2P loan financing. Income aims to democratise the credit market further by offering a balanced P2P model in which all actors – borrowers, investors and LO – are equal partners. Investors receive buy-back guarantees, which – in case of a borrower’s default – oblige LO to repay the invested money to the investors. The platform also sets up an additional financial cushion which ensures that investors are paid out first in the event of a LO default. This is an absolute novelty in the industry.
With its new platform generation, Income is taking P2P lending to the next level. The new mechanisms serve to make P2P lending particularly safe for investors, borrowers and also LO. Only by offering a balanced P2P model will it be possible to fulfill the promise made by the IT concept of P2P, according to which all actors in a network are equal and equipotent partners.
by Kimmo Rytkönen, CEO and co-founder of Income