Daily Fintech

The emerging value chain ecosystem in Marketplace Lending

In ye olden days it was called P2P Lending. You can still see the vestiges of that model in services such as Lending Club and Prosper. Everything happened on one service. However as these marketplaces grew, a networked ecosystem has started to emerge. We are 100% confident that this networked ecosystem will replace the incumbent vertically integrated bank model, even if we cannot see exactly which ventures will thrive and in what timeframe. Many of the problems that drove the news cycle around Lending Club and Prosper in the last few weeks can be seen within the context of this shift from single end to end service platforms to a networked ecosystem. In this research note we outline the players in this networked ecosystem and try to figure out where the puck is headed.

5 Links in Value Chain between Borrower and Lender

          Origination Marketing

Marketplace Lenders still get borrowers/customers in a remarkably old-fashioned way by sending out direct mail to people with high credit card balances. They are in the business of competing with credit cards for lending, but use the same marketing techniques as the credit card companies.

Where the puck is headed:

Origination Technology

One reason why Marketplace Lenders grew so fast is simply that they have better technology to quickly process and analyse borrower applications. The usual rule is you can either build or buy technology. Two companies in the buy category include:

Two companies offering origination technology to Credit Unions could branch out:

Specific to the USA and within a niche one could call Regulation As A Service are the banks that Lending Marketplaces formally originate loans through or use for securization such as:

Web Bank

Cross River Bank

CBW Bank

Where the puck is headed:

Matching

This the core function of a marketplace – think of stock exchanges. This is where network effects rule – if you get a lot of borrowers, this will attract a lot of lenders and vice versa. However the matching functionality alone may not be so profitable, which is why the big Marketplace Lenders have so far aimed to control as much of the value chain as possible.

Credit Analytics and Aggregation

This is where there is a lot of innovation today. Nobody wants a repeat of the subprime mortgage blow up. So Lenders want to analyse the underlying loans as best they can. Origination technology will be judged on a mix of a) Customer Acquisition Cost and b) the quality of the data used by lenders for their analysis (because analytics is always a garbage in, garbage out problem). Lenders also want simplicity, so these platforms also offer aggregation aka portfolio construction. The magic quadrant is the mix of easy to invest and ability to drill down and analyse to the individual loan level.

On the consumer side we have:

NSR Invest

Lending Robot

On the institutional side we have:

Orchard Platform

DV01

Monja

Orca Money

Capital Intermediaries

This is the traditional world of Banks, Hedge Funds, Family Offices, Insurance Companies. As the Marketplaces grew, they needed capital quickly, so they courted these Intermediaries, rather than relying on consumers to lend (ie P2P Lending). However as the Marketplaces court these intermediaries they need to remember two things:

This New Asset Class is just getting started

Today the market has been mostly about re-financing high cost credit cards or overdrawn accounts of SMEs, but the innovation is now also happening in invoice financing, mortgages and real estate.

Today it is mostly about borrowers in America, but the attention is now shifting to China and from there to the rest of the world. Kreditech is an example of a firm going after the emerging markets with some success.

The scale of the opportunity is hard to exaggerate and this is a game where a few big winners will dominate. Apart from traditional network effects based on Metcalfe’s Law, we also have the scale advantage of data. There is no person with a law named for this AFAIK, but it it key to marketplace lending – the more data you have, the better your credit analysis works, the better your credit analysis works, the more borrowers and lenders you get leading to the more data you have…

What will be interesting to see will be the degree to which the winners are vertically integrated (like a traditional bank) vs networked marketplaces. Companies like SOFI and Avant loan from their own balance sheet and Avant sells on 50% of the loans using a random allocation. The Marketplaces such as Prosper, Lending Club and Funding Circle innovated by opening up the Lender side of the market to an ecosystem, which is why we are seeing so much innovation on that side. The next stage may be opening up the origination side so we get a true marketplace with an ecosystem on both sides of the market. Then we will truly have a new asset class.

Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech. Bernard Lunn is a Fintech thought-leader.

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