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@dan-mcgee
Core Banking - May 20, 2016

A recent article by the Bank of England's staff blog (tinyurl.com/p2pbankunder) raised an important point about marketplace lending. 

Their argument is that the disruptive potential is highly limited unless these platforms can pull depositors away from insured investment products at banks (e.g., term deposits) and onto their platforms. The vast majority of funds that support retail and small business lending are retail, not wholesale-owned. As such, marketplace platforms are going to face an increasing drag on their growth unless they can unlock a new source of funding.

This argument is only partially correct. It is highly likely that achieving significant scale in lending will require the platforms to achieve a greater degree of familiarity among retail customers. In a world where many customers maintain banking relationships with only a single institution, marketplace lenders will struggle to pull away lending customers if depositors remain firmly ensconced in their chosen bank.

Additionally, banks are unlikely to redirect excess funds towards marketplace platforms in sufficient volume to affect the market. Banks clearly will want to protect their own lending businesses and so are likely to restrict their assistance to customers they cannot currently serve. Beyond the competitive incentives, increases capital requirements as Basel III is fully implemented will make it impractical to divert funding to marketplace platforms, which are likely to attract relatively high risk weightings.

However, innovations in wealth management may increase the share of total funds available for investment that are controlled by institutional investors. Thus, the argument that retail investors must be pulled onto marketplace platforms is broadened to the point that they must shift their investments towards risky, uninsured assets. Even if retail investors do not themselves invest on marketplace platforms, rising wholesale volumes would be able to support a marketplace lending boom.

The challenge is making marketplace loans into a mainstream investment product held by major institutional investors, not merely specialist funds seeking high returns. In fact, we have seen the first step towards this as marketplace lenders on both side of the Atlantic have begun to securitize their loan portfolios (OnDeck first issued a securitized product in 2014 and Funding Circle recently completed a European SME securitization).

In summary, one key issue for marketplace lenders is to broaden their base of funding by enabling themselves to tap into traditional institutional funds by demonstrating that they can create low-risk securities with strong underwriting standards that still deliver returns.

@dan-mcgee

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