With interest rates steadily at an all-time low, consumers do not gain much in terms of returns when it comes to their savings nowadays. Even worse, some commercial banks have recently hinted at the prospect of setting negative rates, meaning that consumers have to pay in order to store their cash, on top of regular administration fees. Adjusted for inflation, these consumers are collectively becoming poorer over time.
On the other end are credit-seekers, for instance consumers that are indebted due to credit-card repayments, college tuition or unforeseen medical expenditures. The process of obtaining small personal loans through a commercial bank is more than often as complicated as it is likely to be rejected. Even though these consumers are willing to pay some level of interest in order to clear their immediate debts or undertake new purchases, they are (severely) constrained in their ability to do so.
Enter the platform-mediated network: an online community where lenders and borrowers connect. Credit-seekers fill out a loan request, which is listed on the platform for all potential funders to review. Investors construct their own personalised portfolios by (partially) funding requests that pass their judgement. The platform does the rest: loan contracts, interest rates, repayments, special clauses, administration and taxation are all taken care of. The credit-seeker gets a loan at a favourable rate, while investors are compensated by solid market-adjusted returns.
It is perhaps not surprising that this model has seen some relative succes in the past decade. The two earliest platforms in the United States, LendingClub and Prosper, have over the years serviced more than 26 billion USD in loans. The former went public in december 2014. The idea is catching on in other economies as well, most notably in China, where consumer propensity to save is notoriously high. Yirendai and Lufax, two of the largest Chinese platforms, went public on the NYSE as well.
What exactly is the appeal of these platforms? The explosive growth can be explained by a combination of 2 very potent factors:
1) Costs are low, for both sides on the platform. Lenders and borrowers alike benefit from what researchers have dubbed the ‘disintermediation of banking functions’, which essentially entails that expensive middlemen are removed from the process, letting consumers control (parts of) the process themselves. This consumer-at-the-wheel approach depends strongly on a solid community where frauds are called out by other users and investors work together to screen and monitor their own portfolios.
2) Network effects, brought about by informational transparency. The very nature of these platforms is embedded in their openness: once a user becomes a member of the community, a world of information is available. This has positive effects for both credit-seekers, who can review past requests and identify which characteristics make it attractive, and investors, who can learn from the same requests and find out how to assess the credibility of potential borrowers. Cross-effects are prevalent too: when the supply increases (i.e. more investors are looking to buy into loans), demand will follow suit. When demand follows, supply will increase in the same manner. This continuous process of two sides of the market encouraging development has led to near-exponential growth of the platforms. Watch our video to find out more about the functioning of these platforms, the main challenges and future prospects:
