Paper , Order, or Assignment Requirements

1. After reading the attached article (see below), produce a final report covering the following issues:

   (i) Describe the new market model of online/marketplace lending, as discussed in the article. What are the major differences from conventional bank lending? (40 marks)

   (ii) What kind of financial risks are present in online lending? What could be the effects on an economy’s financial stability, if the practice of marketplace lending substantially increases? (20 marks)

   (iii) As it is stated in the article, the market place bosses believe that “…they can weather a downturn because they do not own the loans they originate”. What is your view of this statement? (20 marks)

   (iv) How would you decide to incorporate such online/marketplace lending practices within a regulatory framework? Provide some practical recommendations. (20 marks)
   Online lenders stuck on a hamster wheel
   Doubts creep in over marketplace model’s ‘innovation’
   by Jonathan Ford – FT (September 6, 2015)

   Bankers may like to claim otherwise, but there are precious few genuine light bulb moments in financial services. Ask Paul Volcker. The former Fed chairman once quipped that the last worthwhile innovation in the sector was the ATM.
   That was before the explosion in marketplace lending. Investors have been dazzled by the disruptive possibilities of this new industry, which employs technology to put lenders directly together with borrowers and cuts out many of the costs and inefficiencies of having a bank in between.
   Having emerged at a propitious moment, just as the financial crisis battered banks’ balance sheets into Scrooge-like inertia and interest rates fell to multi-century lows, these online lenders are growing like topsy. In the US, total advances outstanding have increased from $1bn in 2010 to more than $12bn in 2014.
   Investors’ belief in their power to reshape banking has propelled two US operators — Lending Club and OnDeck Capital — on to the stock market, allowing them to raise $1.2bn in public equity between them. Venture capital and private backers routinely chuck money at a swelling population of new entrants.
   Last month, Social Finance, an unlisted US lender specialising in university graduates, raised a reported $1bn in a secondary private funding round. That is roughly as much as venture capital investors put into the entire marketplace industry last year.
   But amid all the growth and excitement, a few doubts are beginning to be heard. Just how innovative really is the marketplace model? Could this be another financial product where a veneer of technology conceals something much more familiar — and mundane?
   Although it is less than a decade old, marketplace lending has already strayed from its origins. The first practitioners called themselves “peer-to-peer” lenders. They connected individual investors and borrowers. The idea was to supplant Wall Street, not become part of it. There was a strong emphasis on community, with loan investors posting personal messages to borrowers about their preferences and reasons for lending.
   The problem was that this did not bring in enough cash. Persuading consumers to lend directly online was a slow and costly business. It was also one that impatient equity investors were reluctant to fund.
   So the industry turned instead to the wholesale markets. Hedge funds and investment banks have proved a much easier sell. Not surprising, perhaps, when average rates on a Lending Club loan are between 7.5 per cent and 25 per cent and bond fund returns are closer to 2 per cent. Institutions now make up about four-fifths of many US operators’ funding. That allows some of the largest marketplace lenders to grow at more than 100 per cent a year. But it also makes them look a lot less like financial innovators — and more like finance companies of yore.
   Like a Household or GE Capital, they depend on markets for access to funding.
   That is, of course, readily available now, given the absence of attractive alternatives. But history suggests that something will at some point trigger a liquidity squeeze — whether regulation, shrinking spreads or a sudden spike in loan losses. Lenders will flee the market. And when this happens, history also relates that finance companies tend to be bought by banks — or disappear.
   Marketplace bosses say the comparison is inapposite. They can weather a downturn because they do not own the loans they originate. As the name implies, most operate as marketplaces for third party investors, although some, such as SoFi, warehouse loans with bank finance before selling them on.
   But as Todd Baker at Broadmoor Consulting points out, this is itself a source of instability. It makes marketplace lenders highly dependent on new business because they get almost no recurring revenue from loans they have written. Take Lending Club, for instance. In the second quarter, it had revenues of $96m, of which $86m came from transaction fees. Strip those out and you would have almost nothing to pay the company’s $100m in expenses. Were it to slow or stop lending, the losses would quickly pile up.
   Marketplace lenders may have innovative technology. But they are on a very traditional financial hamster wheel, racing to generate income to cover expanding costs. In an increasingly competitive market, this can only magnify the risks of adverse credit selection to which these young businesses are prone.
   There is a way off the wheel, of course, and that is to become — or be bought by — a bank. The snag is that banks trade on just 10 to 12 times earnings. Even after recent share price falls, that is far below the valuations that listed marketplace lenders enjoy.