P2P Lending And The End Of The ‘Benign Credit Environment’

Benign Credit Environment

In the age of Peer-to-Peer (P2P) lending, consumers have unprecedented access to funding and lenders have been freed from the traditional constraints of credit risk assessment structure, able to self-define their platforms through a successful business model. This is hailed — as well as bemoaned — by many in the traditional lending market as a source of significant industry disruption, or possibly a Brave New World.

“Evolution of the market isn’t necessarily a bad thing.”

A New Paradigm
“When the Walkman came out, the industry found this fantastic because we’d been buying vinyl records, and now we had to go buy all the records again on cassette,” said Bruce Weber, dean of the University of Delaware’s Alfred Lerner College of Business and Economics, at the 2016 annual conference of the college’s Institute for Financial Services Analytics (IFSA). Weber drew parallels between the time of innovation in music technology and the current disruption in the banking world.

“Because the Walkman was now a must-have technology to us, for the industry, this was a really good time,” Weber added.

Many hail the new paradigm as helping fill some of the banking industry’s most serious gaps, including limited access to funding in emerging markets and for small- or medium-sized enterprises.

“We will reach a tipping point where we will see some implications from all that is happening here,” said Reena Aggarwal, Robert E. McDonough Professor of Business Administration and professor of finance and director of the Center for Financial Markets and Policy at Georgetown University at IFSA. “I really hope that one of the disruptions will be serving the underserved markets that the formal financial sector is not capturing as yet.”

Benign Credit Environment
This is what Glenn Goldman, CEO of Credibly, calls a “benign credit environment,” or an environment where “capital, and therefore liquidity, was abundant.” This allowed for a brief, relatively idyllic period of time where P2P lenders could be narrowly focused on one or two things that were essential to their models and still find themselves easily treading water. Lenders were happily trading less-than-impressive lifetime value for low loan acquisition cost and uninhibited short-term growth.

But all this appears to be changing rapidly. Goldman warns that competition in the lending space and the ability to offer a broader portfolio of loan products to consumers has brought an end to the good times.

“We are no longer in a benign credit environment, whether that’s being brought on by economic headwinds, or over-lending in certain sectors,” write Goldman in the LendIt 2016 blog. “There’s the realization that risk has been mispriced, which is becoming apparent in the kind of analyses that rating agencies and investors are doing on existing securitizations of consumer loans. There are fewer dollars being invested in the marketplace space, and those dollars are being much more carefully applied.”

The Natural Evolution
While some lenders may see this as a signal to panic, Goldman cautions that this evolution of the market isn’t necessarily a bad thing. Rather, he describes it as “the natural evolution of innovative and disruptive industries” that markets are moving to embrace broader, sturdier business models — models where doing one or two things well is supplanted by doing “everything” well.

“As a result, our industry will evolve to a place where a few dozen players — the ones who started focusing early on the notion that everything matters, or who are able to pivot and address that fact — will be the survivors in a much stronger, healthier industry,” concludes Goldman. While warning about the “rough waters” that lay ahead, Goldman asserts that the lenders who emerge will find themselves well-prepared to deliver high quality loan products to their customers.

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