May 18, 2015, 9:46 AM ETPanel

What Online Lending Means for Banks, Businesses and Borrowers

Marketplace lending (formerly "peer-to-peer") is projected to grow from $9 billion in the previous year to $20 billion, driven by efficiency, speed, and access to capital.
The primary value proposition is the bifurcation of risk at origination, allowing investors to fund loans in small increments (e.g., $25) that match specific risk tolerances, unlike traditional balance-sheet lending.
Growth is fueled by a shift from brick-and-mortar banking to digital-first experiences, with application-to-funding cycles averaging roughly three days.
Aggregators like Credit Karma and LendingTree are creating a "flywheel effect," driving traffic and conversion rates for lending platforms.
Consumer behavior shifts, particularly among millennials, favor instant online decisions over traditional branch interactions.

Platforms emphasize that regulatory arbitrage is minimal; they face over 100 layers of regulation across state and federal securities and lending laws.
Lenders are registered with the SEC for retail investments and partner with chartered banks to ensure loans comply with identical banking laws (e.g., Fair Lending, Truth in Lending) applied to major banks like Citigroup.
The U.K. market benefits from a simplified regulatory framework that allows investment through retirement accounts (pensions) and tax-deductible losses, accelerating adoption compared to the U.S.
High compliance barriers act as a "moat," preventing new low-quality entrants; platforms must meet public company filing standards and be registered in every state where they operate.
Unlike banks, these platforms do not hold FDIC-insured deposits, eliminating "too big to fail" moral hazard and shifting risk directly to investors.

Underwriting models have evolved from relying solely on FICO scores to using hundreds of data points (e.g., Prosper uses ~400 points) and machine learning for higher accuracy.
OnDeck utilizes a proprietary "OnDeck Score" that analyzes holistic business data (P&L, balance sheet, cash flow) rather than relying on unreliable FICO scores for small businesses.
Platforms employ a "flip the process" application model: offering an instant rate based on self-reported data, then performing back-end verification only upon acceptance, reducing operational costs and improving customer experience.
Lenders claim their data-driven, automated underwriting reduces human bias, leading to better credit access for underserved demographics, including minorities and women, who are often rejected by traditional banks due to relationship-based underwriting.
Macro-economic data derived from loan applications serves as a leading indicator; for example, FICO score drops often precede broader economic stress by six months.

The investor base has shifted from predominantly retail individuals to institutional investors (banks, hedge funds, asset managers), who now provide the majority of funding due to capital depth and track record validation.
Platforms maintain a "random allocation" mechanism to ensure fair distribution of loans between retail and institutional investors, preventing adverse selection.
OnDeck reduced its risk retention from 25 cents on the dollar to 5 cents on the dollar as institutional capital capacity increased.
Prosper recently raised $165 million specifically from a group of banks, while Funding Circle raised $150 million to fund its "war chest."
Industry leaders anticipate the need for diversified, permanent capital sources (e.g., BDCs, closed-end funds) to survive economic downturns without relying on securitization markets that may freeze.
The U.S. market currently lacks a robust secondary market for loan liquidity, unlike the U.K., though platforms are developing mechanisms to manage investor duration concerns.

Traditional banks are transitioning from competitors to partners, leveraging platforms' technology and data to serve segments where traditional lending is cost-prohibitive (e.g., loans under $500,000).
Lenders argue that technology giants like Amazon, Google, and PayPal are unlikely to become primary lenders due to balance sheet constraints and risk aversion, preferring instead to partner with established platforms or provide capital for specific commerce needs.
Google partners with Lending Club to act as the "rails" for financing their value-added resellers, utilizing platform infrastructure rather than holding debt on their own balance sheet.
Amazon's lending program focuses on inventory financing for merchants to increase inventory turns, which complements rather than directly competes with expansion capital loans provided by marketplace lenders.
Banks are expected to evolve into "utilities" or aggregators, partnering with specialized platforms for specific products like credit cards or small business loans while retaining core deposit functions.

The small business capital gap is universal; platforms like OnDeck and Funding Circle are expanding into Canada and Australia, adapting their models to different banking structures (e.g., highly concentrated markets in Australia vs. fragmented U.S. market).
China's marketplace lending sector is significantly larger, with over 2,000 P2P lenders; the largest single Chinese platform generated over $10 billion in volume last year, exceeding the combined volume of all U.S. platforms on the panel.
Lenders plan to scale through operational rigor, hiring and training staff months in advance to match predicted loan volume growth, avoiding the "overgrowth" pitfalls of the 2008 crisis.
Transparency concerns regarding short-term small business loans persist; some platforms market "cents per month" costs rather than Annual Percentage Rates (APR) to avoid obscuring high annualized rates on short durations.
Brand trust remains a critical differentiator for attracting both retail investors and borrowers, particularly in markets where direct mail conversion is lower and relationship-based lending historically dominated.