Marketplace lending is one of the biggest success stories in financial services. The alternative finance providers facilitate loans, for borrowers, directly from investors who are looking for a higher returns. Also known as peer to peer lenders, the technology led new age lenders stepped in where banks left a huge gaping void.
The outcome has been a win/win solution for both the new Fintech (financial technology) players as well as businesses and individuals who now have access to finance that they just couldn’t access from traditional banks.
It is difficult to believe however, that the exponential growth of marketplace lending has not only been fueled by customer demand, but also by government and regulatory support.
The UK government spotted the opportunity created by these alternative lenders, to get across much needed finance to small and medium sized businesses (SMEs), especially after the financial crisis when such financing was crucial to restart the ailing economy.
Regulators introduced a light touch regulatory framework for marketplace lenders, in an effort to let this budding industry flourish. The regulation provided certainty and much needed credibility for this sector. A credibility boost gave investors more comfort to invest and also attracted institutional investors.
With greater levels of institutional money pouring in, the industry moved from being a peer to peer lender to a marketplace lender, starting to behave more like a bank.
In my last blog post, The Future of Peer to Peer Lending, I highlighted the increasing regulatory pressure that this sector will face, given its rapid growth rate. Regulators have awoken to the potential that these new age players can impose a risk on the wider financial system. I concluded with the question asking whether we could see Basel III type of rules being imposed on marketplace lending.
This City AM‘s article highlight’s regulatory concerns around marketplace lending. John Griffith-Jones, Chairman of the Financial Conduct Authority (FCA) told the Treasury Select Committee that
While one wants to encourage alternative sources of lending, one doesn’t want to open up risk. I think sooner or later these platforms will tend to offer packages rather than lending to individuals. At that point, they become awfully like a bank, and I think it’s very important for the regulator not to allow regulatory arbitrage in the system. What I can assure you is that we’re not asleep at this wheel. What I can’t assure you is when is the right moment to intervene – but it is being kept under constant review.
Basel III brings about significant regulatory reform in the banking sector, hoping to avoid the potential for such banks to create another financial crisis. It is designed to improve the regulation, supervision and risk management within banks across the globe.
At its core, Basel III introduces a risk based capital adequacy framework, ensuring that banks hold adequate capital buffers for the risks they take. Such a framework requires accurate, and often, complex methodologies to measure risks. The framework also require banks to prudently manage liquidity risk (something that often cause banks to fail) and control leverage within their business.
Basel III also aims to strengthen governance and reporting standards, ensuring proper oversight and external scrutiny.
Marketplace lending could have a similar regulatory framework imposed on it, because regulators want to controls risks posed by these new players, and most importantly, they want to close any regulatory arbitrage gaps.
Marketplace lending could face significant consequences:
- With lean operations and high marketing costs, marketplace lenders are already operating with tight margins. These margins may be further squeezed by increased risk based capital requirements, and the additional cost of compliance.
- Using technology and not hampered by regulation as much as banks, marketplace lenders are better, faster and more efficient compared with incumbent players. Bank like regulation may erode this very advantage that alternate lenders have.
- With risk and compliance resource already coming at a premium, because of a shortage in supply, a more stringent regulatory framework will exacerbate this shortage and drive up resourcing costs. This could force new age players to look for more streamline solutions such as outsourcing.
On the positive side however, such a framework will significantly strengthen this sector and increase barriers to entry. Market place lenders that take risk management seriously, will win greater market share because weaker players fall by the way side. Such disruption also present merger and acquisition opportunities and open up more joint venture opportunities with bigger players.
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Over to you! Would do you think about bank like regulation imposed on marketplace lending? Leave your thoughts below and start a new discussion.