Loan origination risks have shifted from the “crowds” to the “Wall”

By Efi Pylarinou

Regulatory constraints posed to financial institutions post 2008 crisis, led to a squeeze of financing services traditionally offered from financial institutions to retail or small businesses. Fintechs naturally, came in to fill-in a real need. Peer-to-peer lending started early on (right after the 2008 crisis) and the journey towards the IPO of Lending Club and the growth of the overall market was not necessarily full of roses.

Retail investors that got involved early-on in these online person-to-person marketplaces, did get hurt because they were novice and had no experience in managing the risk of loan portfolios. Today, they are advised to spread their holdings across 100 notes or more and are provided with better guidance on the lending marketplaces (ratings etc). The US and the UK are more mature markets and coming up and promising are, Canada, Australia, and Hong Kong. The rest of Europe and Isreal are developing too. We have come a long way from 2008, when loans on Lending Club and Prosper were funded by multiple lenders contributing a minimum of $25 toward a loan financing. Today, 65% of the loans on the two aforementioned platforms are funded as whole loans, usually by institutional money (Quartz Report).

From a 35,000 feet point of view, the reality is that regulators have managed to reduce risks associated with financing activities overall, WITHIN the traditional financial services industry. Loan portfolios, counterparty risks and probably of default with collateral values dropping like falling knives; are all diminished substantially UNDER the umbrella of the traditional providers. OUTSIDE the traditional financial services sector, as Alan Kohler at ABC reports referring to Fitnech lending players: “these players don’t need a capital buffer for lending”. So, the financing machines are pumping notes (loans) outside the Walls! Pirates have taken hold of the mission, which is a noble one: consumers needing loans, students facing increasingly expensive education, and small businesses needing more capital etc. The exposure, collateral, and default risk of these unregulated originators has NOT BEEN TAKEN INTO ACCOUNT.

The market is not the DOW or the S&P500. These are indices. The aggregate risk of lending is being measured within the traditional financial system but the market is growing outside of it. More scary is the fact that most lending marketplaces are run by entrepreneurs that correctly sensed and filled the unserved financing needs but don’t necessarily have the risk management expertise of such a business. In many cases, they have positioned themselves as platforms that have delegated the risk management to investors. DIY is the modus operandum for 30%-40% of their business that remains truly peer-to-peer and the rest has been transferred into the hands of the old professionals that can diversify due to their size and have experience to manage the underlying risks.

When the black swans flock over these marketplaces, then the regulators will have to let them fail because they are NOT too Big to Fail. Do you agree that regulators have managed to reduce the risk of “Too Big to Fail” in the origination space? Do you agree that more than half of the risk management of the Fintech origination business is gracefully, being transferred under institutional “roofs”? Will these prove more capable of managing the risks?


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