Part 2 - What needs to be done now to get Online Direct Lending (ODL) / Peer to Peer Lending (P2PL) back on track for compliance, profitability and sustainability?

The first in this series of blogs, published on 26 January 2021, looked at "How and Why the Industry lost its way".  We looked at developing sustainable / profitable business models (not just going for growth), buying systems based on the true useful life of the system, ditching "recording systems" in favour of "process automation systems" and changing the dinosaur payment systems that serve only to delay transactions.

All the problems of the past but there is hope, and potentially an industry-wide solution.

P2PL Market Development

The UK P2P Lending market has been through various stages of development from 2005 to 2020, including movement from Consumer Credit Licence to FCA regulation as later enhanced, the introduction of the Innovative Finance ISA, and then institutions becoming increasingly involved.  With this, the term "Peer-to-Peer" was overtaken with "Marketplace Lending" and then later "Online Direct Lending".  The P2PL movement could no longer claim "We are doing a much better job than the banks!", when the banks are still making huge profits from their lending and borrowing, and P2PL was regularly going cap in hand to shareholders to fund losses.  So, after 15 years, a complete review of the ODL market is due.

What needs to happen now?

Ignoring for a moment the inevitable setup costs and the given key cost item of customer acquisition for ODLs, it is clear to me that the primary issue to transform this nascent industry is in the more efficient acquisition and use of technology.

In the first instance, technology was the golden ticket that would enable the "win-win-win" scenario of low-cost loans for borrowers, healthy interest rates for lenders and a profitable growing business for the P2PL company.  However, many P2PL industry leaders have found themselves looking at how they can fix their business model and the imbalance between fee income and overhead costs.

However, help is arriving in one area, in the guise of Open Banking, wresting control from the banks, providing data access and restoring real time automation of the payments process.  This will boost the efficiency and cost effectiveness of credit risk categorisations and the collection of borrower repayments, hence improving the all-important liquidity.

Fundamentally, the more the ODL company makes in fees and margin on each loan, the more likely it is to be profitable.  Having a small team that can process large numbers of loans, including payments and banking, enabled by effective software that supports high levels of automation, is a crucial step towards profitability.

This is the Time for Online Direct Lending to Become Profitable and Sustainable

From a technology viewpoint, it is my view that there has been a laudable amount of focus of development activity concerning improvement of the front-end customer experience.  Unfortunately, however, this has been to the detriment of the automation of back office and administrative operations, which probably represents about 90% of the business processes.  Automation in this area has been the focus of our attention.  We hope that companies in this sector are now beginning to understand what was needed the first time round.

With the increased requirement for both borrowing and lending/investing in these tough times, could this be the moment that the industry rises to the challenge?  Low interest rates and high demand for loans could be the catalyst, again, to give emerging ODL companies (and traditional lenders looking for a new online sales channel), the opportunity to deliver their online services profitably.  Or perhaps some of the established companies will make the appropriate changes to achieve their aim of long-term sustained profitability, through the clever application of automation technology.

What is the Solution for the Sustainable Future of Online Direct Lending?

There is no doubt that the kickstart for the nascent P2PL industry was the financial crisis of 2008.  Now ODL has to step up to the plate, to provide lenders and borrowers the service they need as the world recovers from the pandemic.

Having done the research and analysis can the industry now see how ODL could be delivered:

• safely, compliantly and cost effectively for all potential customers, and
• profitably and sustainably for the market players?

It can, and this is how...

One strong option to turn around the sub-par and loss-making start for individual P2PL / ODL companies, is to look to outsource the technology aspects of the business.  Depending on how this is done and with whom, there is potential for huge savings in costs of software, staff and office accommodation.  However, one should choose carefully the technology with the highest level of automation and holistic coverage of requirements.  Outsourcing technology to numerous suppliers for various different parts of the overall requirements can add layers of transaction costs that each nibble into the slim margins available.

So, the above might be part of a solution for certain P2PL / ODL companies, but is there a whole of market solution that will benefit all the players and stakeholders?

The answer is for a generic Online Direct Lending primary and secondary marketplace to be made available to provide loan market facilities, matching retail borrowers and investors under FCA regulations.  It will also provide for business borrowers originating loans and for institutional lenders to sell, refinance or invest in loans.  The marketplace will supply the day-to-day presentation, matching, processing and servicing of the loans.  Loan requests will be entered via the market web site individually or via an API bulk loan upload facility for lenders, brokers and institutions.  Most lenders' funds will be matched automatically with borrowers' loan requests or matched with loans offered in the secondary market.  This will enable lenders to focus on their niche lending or broking function and not worry about the ongoing loan processing.  It also provides the mechanism for the sale or refinancing written loans via the secondary market.

This "Market As A Service" will have a fee structure primarily based on transactions processed for the whole of the loan lifecycle.  This approach means that prospective businesses can launch ODL and P2P Lending without the attendant significant upfront technology investment, development and implementation time or its associated staff and office cost.  They would be "in business" typically within three months and with a fee structure based on pay per transaction processed and with profitability already in sight.

This service could also be made available in the form of a "Platform As A Service" with a branded portal for businesses and institutions who wish to have their own front-end to the marketplace.

Banks should participate as members of this lending market, perhaps for loans that would be considered unsuitable or unprofitable in their normal course.  This would be seen as an essential step towards banks becoming more "FinTechy" themselves.  It would certainly be of benefit to their customers, and therefore the bank, by adding customers, liquidity, credibility and trust to the marketplace as a whole.

This is an achievable next step for the UK ODL market and beyond.  The technology and infrastructure is available.  Potential stakeholders should share thoughts and, perhaps, this can be constructed as a profitable route for the future of P2PL and Online Direct Lending.  We see this to be of benefit to the market as a whole, retail, business and institutional lenders and borrowers, including banks, existing and also new firms setting up.  And this cooperative effort will help get the economy moving again!