The Power of Peer to Peer Lending

Two billion people worldwide lack access to a bank account or financial institution and have to use alternative payment methods to conduct transactions.

This signals a huge vacuum for easier access to financial transactions that, once filled, would lift huge barriers to economic growth for the marginalised across the globe.

To tackle the issue, the World Bank has set a goal of securing universal access to formal financial services by 2020.

In recent years, technological innovators have made giant leaps towards plugging the gap by enabling people to borrow and lend money without using an official financial institution as an intermediary through peer to peer (P2P) lending.

Traditionally, individuals and small businesses who want a loan would have had to apply for one through a bank.

But with P2P lending, borrowers take loans from individual investors who are willing to lend their own money for an agreed interest rate.

Those who want to avoid being charged high interest rates or who may otherwise be rejected for a loan application because of poor credit history, can opt for this alternative way of borrowing funds.

The profile of a borrower is usually displayed on a peer to peer online platform which investors can assess to decide if they would want to risk lending their money.

These platforms benefit both borrowers and investors: lenders generate income from interest on loans, which can often be higher than interest earned through saving accounts or stock market return on investment.

Meanwhile, borrowers benefit from a more favorable interest rate than one they’d otherwise get from a bank, or from access to financing they might not otherwise have gotten approval for.

This knocks out the need for a third-party in a range of transactions, streamlining financial services and breaking open the barriers for the unbanked.

The world’s first P2P lending platform, was launched in 2005 in the UK, and P2P platforms have since seen extraordinary growth, developing into a vast global industry.

And it’s no surprise, with its potential to give the 2 billion people globally who are unbanked access to digital currencies.

However, no region globally has come even close to matching the explosive and unparalleled growth in P2P lending witnessed in the world’s second largest economy: China.

China saw its first P2P platform launch in 2007 and by 2013, this figure had skyrocketed to 800. By May 2018, there are a total of 6,142 platforms operating in China.

In 2016, P2P platforms in China recorded over 3.4 million investors, while growth in the sums of capital involved in P2P lending shot up from CNY21 billion ($3 billion) in 2012, to CNY 1411 billion ($216 billion) in 2016.

This dwarfs’ P2P platform growth in the West: in 2016 in the UK there were a mere 9 authorised firms offering loan-based crowdfunding platforms, the European Union had 24 platforms with a €3.2 billion volume, and the USA 25 with $29 billion volume in loans originated, according to Dr Chuanman You, a FinTech expert based in Tel Aviv University, in an Oxford Capital Markets Law Journal report on the recent development of FinTech regulation in China.

China’s phenomenal growth in the P2P lending industry is driven by both the undersupply of funding for Small and Medium Enterprises (SMEs) and low-income households by conventional banking institutions, and on the other hand, by the high yield rate of investment in the P2P lending industry which enticed a supply of capital from both retail and institutional investors, according to Dr You.

While funding constraints for SMEs and low-income households are a global problem, the issue has been exacerbated by China’s State-Owned Enterprises (SOEs) dominant economic structure, combined with a repressive financial policy.

The unprecedented FinTech boom has transformed China into one of the world’s largest online alternative finance markets by transaction volume, with P2P lending at the forefront of sector growth.

The explosive growth in P2P lending has liberated the Chinese financial market, but with great innovation comes great uncertainty.

The surge of this sector has brought an array of credit risks, business operation risks and information security risks, which could trigger market, regulatory, and even governance failure.

In 2016 nearly 50% of Chinese P2P platforms were problematic, with fraud, fund flight and illegal fund-raising frequently reported. By May 2018, about 2,058 platforms have been reported to encounter liquidity difficulty or other more severe problems.

China’s initial lack of a comprehensive regulatory regime contributed to the phenomenal growth of P2P platforms, but also generated huge market risks which could endanger the industry’s sustainable development.

Globally, policymakers face the challenge of balancing regulation that protects the industry without curbing the fledging sector’s growth.

While in the UK and USA regulation has been better established, this may have slowed growth in the P2P lending sector.

China introduced the first comprehensive legal framework into its P2P lending market in 2015, providing much needed legal protection for participants of the China market.

And with China being by far the largest sector player, Dr You argues that this “may also contribute a new model to the global regulatory map for the sustainable growth of the P2P lending market, and the FinTech industry in general.”

However, there’s another tool in the market which is helping to fill the short-comings of current transaction systems.

The incorporation of blockchain into P2P lending platforms could critically not only reduce risks but also boost efficiency for all involved, creating an inherently transparent and tamper-resilient network through which valuable information can be tracked and traded.

“Another significant benefit from blockchain technology is loan tokenisation,” explains Dr You.

“The conventional offline lending market has profoundly engaged in the securitization of loans and trading of these loan derivatives, which has yet become a normal in the nascent online P2P lending market.

“Blockchain technology would enable tokenisation of loan assets originated through P2P lending platforms and facilitate investors to securitize and trade their loans with other peers,” he says.

The introduction of blockchain enabled P2P platforms, together with improved global regulation, are challenging previous dominant market monopolies by conventional banking institutions.

This will not only revolutionise the $430 billion international remittance industry, but also spur tremendous market growth, giving the unbanked access to finance and removing barriers to investing.

The potential impact on emerging markets cannot be overstated.

For SMEs and people who otherwise might struggle to get a loan or have access to finance, the P2P lending platform has been a transformative enabler.

And as more of the two billion currently excluded from the financial market gain the ability to both lend and borrow through P2P platforms; the world could witness an economic shift towards greater global equality.

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