Thoughts on Future Pricing for P2P Lending Services

Multi-sided platform are platforms that need to attract two or more customer groups in order to create value. They interconnect these groups serving as intermediary setting the rules. The platform need to achieve satisfactory results for both/all sides.

One example are video game console manufactures. The product will only attract enough buyers if enough games are at available. Developers on the other hand will prefer those manufactures, that already sold large numbers of consoles and thereby offer a large potential of customers.

Another example is Google. One customer group are the users. The value proposition here is ‘free search’.  With the huge audience Google has and the algorithms for matching, Google can offer targeted ads to advertisers.

So Google gives away search for free, in order to make profit from charging advertisers.  In this case there was not much alternative in deciding which customer segment to charge. But sometimes both customer segments are charged and it is hard to decide which side to charge (more).

P2P Lending services are obviously multi-sided platforms, too. They need to match borrowers and lenders. Ideally there will be roughly the same level of demand as of supply of capital.

The current situation is that most p2p lending services charge borrowers more fees than lenders.

Possible causes for this are:

  • At the inception of p2p lending services, opinion was that it is harder to convenience lenders to trust this unproven model and unknown new company running the service – therefore lenders were charged nothing or little to not build entrance barriers
  • Orientation on established models for loans – banks charge borrowers fees too, therefore borrowers will accept these as usual
  • Cost-bast pricing: In vetting a borrower the service will incur costs, whereas a new bid by a lender will incur close to zero costs as it can be processed automatically. Even higher than the vetting costs are the customer acquisition (marketing) costs to obtain borrowers.

Now years after launch, most p2p lending service are “short” of (good) borrowers. Their lenders have a surplus of capital that could be lend out, would there be more loan applications on the platform. And typically customer acquisition costs are much higher for winning new borrowers than for winning new lenders. Furthermore borrowers must be acquired over and over again, whereas lenders remain customers for longer periods of time and reinvest capital.

The logical consequence would be for the p2p lending marketplace to change the pricing. By charging borrowers less and charging lenders more, the value proposition to borrowers would be lower APRs, attracting more borrowers.

A counter-argument voiced against this, is that pricing would not change, because lenders would just raise the interest rates they offer to cover the higher fees. This will happen to some degree, but I think how much is dependent on the model the p2p lending marketplace works. In a market place where lenders do set interest rates themselves (e.g. Ratesetter) this will in my opinion be likelier than in a markplace where the operator sets the interest rates (e.g. Lending Club) or where the initial rate is set by the borrower (e.g. Smava) and can possibly be bidden down (e.g. Isepankur). Furthermore even if costs for borrowers overall would not change, the marketing-message could – ‘fee-free loans’ will be more appealing.

This change would need to be a gradual shift as existing lenders are accustomed to current prices and will resent higher fees. For the p2p lending service the effect per loan could be neutral. The amount of fees earned per loan would stay the same, just the proportion of the parts payed by lenders vs. borrowers would change.

The most radical move would be for the p2p lending service to give the loan fee-free to borrowers. But the p2p lending service faces the risk of ‘over-charging’ lenders. Should lender ROI be perceived to low in relation to the risk then lenders will stop reinvesting and the balance between supply and demand would be in jeopardy.

New launching p2p lending services will also be prohibited from trying this ‘free for borrowers’ approach as

  • they need to have low entrance barriers for lenders (see above)
  • in some markets are in competition to other p2p lending services and lenders will compare fees and prefer lower priced marketplaces

However ultimately the lender group might be attracted by the p2p lending service that can offer the largest borrower demand. Even if another service had lower lender fees, the limited borrower demand on that marketplace and the resulting temporarily higher ROI would be lowered by lender competition with lenders underbidding each other.

I asked some industry leaders for comment.

Alexander Artopé, CEO of Smava, replied that he thinks the analysis part is mostly correct. But for Smava he says, the solution is different. Smava customer’s do not compare the product to banking products but rather see it as an alternative offering a ‘social return’. Lenders are looking for a good ROI in connection with planning reliability. Borrowers seek a fast and easy obtainable loan without the need for securities. Smava strives to offer a better product than banks.

Added after publication: Mariano Carozzi, CEO of Prestiamoci, Italy comments:

… At the moment the volume [at Prestiamoci] is quite small and we have a promotion for both: the fee for lenders is free and the fee for borrowers is a half (mainly to cover the credit risk management).

In my humble opinion, you’ve raised a main question for P2P business and the Smava and CommunityLend ‘s answers are clear….

Colin Henderson, CommunityLend, comments:

You have landed on a very topical point.  Some lenders in the US  have just increased borrower fees.  My take is that you are accurate in your assessment that the balance needs to shift to less fees for borrowers and there are three reasons in addition to your points in my humble opinion.
As P2P lending matures and seasons, the quality of the portfolios will get over the initial concerns for high delinquency and bad debts.  This will happen because all the participants are totally focussed on risk management now.
The second reason is the subtle shift to institutional money as lenders.  This is tied to the first point about risk management.  Institutions whether banks or some type of fund are seeking high fixed income returns and P2P offers that prospect, provided the portfolio quality proves out.
There is a third shift which we at CommunityLend are leading the charge on and that is on the borrower side.  At CommunityLend we believe it will take too long to reach scale using online marketing for borrowers, so we are going after origination channels focussed on sales financing at point of purchase.  Through we are providing dealers (home improvement at first) a sales portal to provide financing at point of purchase.  The portal allows dealers to manage their sales leads and work them through the sales funnel to eventual loans.  The efficiency of our P2P platform is able to provide dealers and their customers a sleek and efficient access to reasonably priced lending.
So in summary while we see P2P remaining the flagship offerring, it will be B2B (dealer originated, sales finance borrowers to institutional lenders) that gets us to scale.  That B2B model as described brings high quality borrowers who have other financing alternatives, so borrowers fees will naturally be under pressure.  The corollary is that these borrowers bring even better quality being a higher preponderance of home owners and more importantly seeking financing related to a purchase, versus seeking credit.  That higher quality will reduce the price pressure from lenders because they can get genuinely high fixed income returns with low bad debts.

What is your opinion, dear reader?

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5 thoughts on “Thoughts on Future Pricing for P2P Lending Services

  1. Interesting discussion. Certainly in the US there is plenty of room to scale from a p2p perspective, but I think it is inevitable that in the long run we will move to a hybrid B2B/P2P model that Colin Henderson suggests. The institutional money is already starting to come in to Lending Club and to a lesser extent Prosper here.

    From a borrower perspective the origination costs are very high in the US, particularly when compared with credit cards, most of which have no origination costs. To be more competitive from a borrower perspective these costs need to come down. I would assume that as underwriting improves and more automation is introduced that will happen. But it hasn’t happened yet.

    Having said all that p2p lending is still growing in the US and while there may be a slight oversupply of investors here, many loans go unfunded (particularly on Lending Club). What I see as the biggest hurdle for p2p lending right now is the general ignorance of it still in the general population. Everyone needs to do a better job to promote the concept for both lenders and borrowers. In this country the industry could easily be 100 times larger than it is now and still hold a very small percentage of consumer debt.

  2. When Lending Club lowered the interest rate on all of their A loans, I stopped investing in them. I felt like I was still taking a relatively large risk lending to a person I will never meet, and at 5% return, I wasn’t getting a reasonable return based on my perceived risk. If Lending Club raises any of their fees to lenders or reduces interest rates on lower grade loans, I will vote with my feet and deploy my capital elsewhere.

  3. If the Credit Unions in UK were doing a Good Job, there would be less need for P2P lending

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