The way bidding works at p2p lending service Ratesetter will change on June 24th. Ratesetter informed investors
Currently your money is re-invested at the higher of “Your Rate” (i.e. the rate you have specified) or “Market Rate” (i.e. the rate that is worked out daily at RateSetter looking at the whole market). Once re-set to Market Rate it stays at that rate which resulted in some scenarios where your money could be sitting at Market Rate unmatched when in actual fact your specified rate was lower.
From 24th June, your money will simply be put on the market to be re-invested at your specified rate. Simple as that.
It is worth saying that if the highest borrower bid at the time of your re-investment is higher than your specified rate, your money will be matched at that rate.
So, we hope that you can now use the “Your Rate” functionality to better control the rate at which you re-invest. One way of looking at it is that is like a floor – you will get at least your rate, or the best borrower bid if that is higher.
There has been some discussion among investors what this means and what actually changes for investors. The way I interpret it (but I am not even a Ratesetter investor) is that the market rate will become less important as Ratesetter could advice the borrower at what rate his loan request would match instantly. Since many investors will not micro-manage their set rate and only login occasionally it will lead to a broader distribution of interest rates set as ‘Your Rate’ and thereby reduce volatility. E.g. should interest rates move upward on the market (for whatever reason), unchanged ‘Your Rates’ at lower levels from earlier times will delay and slow the rise (provided they have unused cash from repayments in their accounts). But let’s hear opinion of actual Ratesetter investors in the comments, please!
Everybody talks about the win-win situation p2p lending offers for lenders and borrowers. By cutting out the large spread a bank takes when making a loan, the lender can get a higher interest rate, than he might in a savings account and the borrower may get a lower interest rate, than using his credit card. But who does actually decide what the interest rate for a p2p loan will be?
Several market mechanisms have developed. P2P lending services use combinations of these to built their platforms. I’ll describe some of the elements:
Individual Loan Listings vs Markets: With Listings (e.g. Prosper, Lending Club, Auxmoney, Isepankur) lenders can look at individual loan listings and see multiple parameters (e.g. credit grade, income, DTI, occupation, location,…). The lender can select (“filter”) loans based on his strategy. This is not necessarily a manual process as he can opt to use automatic bidding tools that make the selection for him based on criteria he set in advance. Other p2p lending services use Markets (e.g. Zopa, Ratesetter) which combine loans based on broader criteria (e.g. loan term, or credit grade). Here a lender can only decide which market to invest into, but does not pick individual loans.
Close at Funding vs Auctions: Some p2p lending services close loan listings once they are 100% funded. The loan is then originated. Others uses an auction process where the listing is open for bidding for a set time. If the loan amount is 100% funded then the bidding continues for the remaining auction period. New bids at lower interest rates push out old bids at higher interest rates, thereby lowering the final interest rate for the borrower. Some p2p lending services allow loan listings of both types or let the borrower prematurely end an auction (e.g. Rebuildingsociety, Isepankur, Assetz Capital).
Uniform vs Mixed Lender Rates: After an auction the interest rate for the borrower can be set at the rate of the highest successful bid. In this case all lenders on the same loan get the same uniform interest rate (e.g. Isepankur). Another option is to calculate the interest rate as an aggregate of all successful auction bids. In this case each lender gets the rate he did bid – there will be a wide mix of lender interest rates on the same loan (e.g. Rebuildingsociety).
Who does decide what the interest rate will be on a p2p loan
I. Borrower sets interest rate
The borrower decides, what (maximum) interest rate he is willing to pay (e.g. Smava, Auxmoney, Isepankur). The lenders can then decide, if they want to fund this specific loan at that rate or not. If there is an auction and lender demand is strong, then the borrower may get the loan for a lower interest rate then specified. Obviously lenders will fund loans with most attractive rates first and other loans will go unfunded. These borrowers can react by relisting at a higher interest rate. Continue reading →
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. Continue reading →