Crowdlending: Small, but Strong


Source: Eric Schreyer, 09.02.2014 – Crowdlending 2013 data: The peer-to-peer lending industry has experineced 90 percent year-over-year growth, says the International Organisation of Security Commission (IOSC). Prosper leads the list of eight platforms with a 7.0 percent default rate while Zopa comes in lowest with a 0.2 percent default rate.

“Quantitative easing in many jurisdictions has driven interest rates close to their zero lower bound. This in turn has driven a search for yield pushing investors towards alternative forms of income generation. In this climate, peer-to-peer lending has developed as a vehicle for borrowers to obtain a loan at a lower interest rate than through using traditional avenues of credit provision such as banks. Additionally, peer-to-peer lending offers a higher rate of return than through traditional investments, such as a savings account or government bonds. Further, many savers have inflation adjusted deposit rates that are often negative, impelling them to search for better returns on their savings. Consequently, growth in the peer-to-peer lending market has been exponential, particularly after 2010 when the industry self-imposed restrictions on borrower creditworthiness in order to tackle high default rates, e.g. when Prosper saw default rates of 30% in 2009.

Investor Profile

Littel research has been conducted on the demographics of the investors who use peer-to-peer lending and equity crowd-funding platforms. One study conducted by Pierrakis and Collins in 2013, for a report by Nesta, is focused on the demographics of 600 lenders of Funding Circle in the UK. The report shows that most of the lenders are between 40 and 60 years old. Almost 90% are experienced investors in securities, while almost 40% have more than 10 years of experience working with SMEs, with 83% being male. The median investment size was £50 and the median number of investments is. The median total investment is £2,000. Although this study is not comparable with other platforms and countries and complete and comparable data is not publicly available, it shows relatively experienced retail investors investing small amounts of money in a great number of projects.

Helping economic growth

Market-based finance provides credit to the real economy and FR crowd-funding is no exception. This is the benefit most cited by governments who want to encourage the growth of SMEs, and the role they play, in their respective economies. SMEs are an important engine of economic growth. As such, any mechanism that helps those entities more efficiently access capital for their development and expansion helps job creation and aids economic recovery. While some jurisdictions do not offer this form of capital raising, some others encourage investing in ventures like SMEs through this market activity. This has been the case in the USA with the introduction of the JOBS Act (Jumpstart Our Business Startups Act). The major benefit of peer-to-peer lending is its ability to efficiently and quickly lend money for personal loans, even if these personal loans include business projects. This has facilitated the flow of credit, which has been severely restricted since the outbreak of the financial crisis in 2008.

Risk of default

Default rates are an important consideration. When Prosper, one of the largest peer-to-peer lending platforms in the USA, debuted in 2006 it had a low threshold on the creditworthiness of the borrowers able to obtain loans from the platform. Prosper accepted borrowers with a credit score as low as subprime 520. It expected lenders to differentiate between investment opportunities through consideration of interest rates, with higher interest rates relating to higher risk investment opportunities. The higher rates of return associated with the less credit-worthy borrowers was compounded by the auction system used by Prosper at the time, which pushed down interest rates as more lenders got involved.  The result was industry-wide high default rates, which at times reached 30% at Prosper. The SEC issued a Cease and Desist order in 2009, arguing that Prosper was selling unregistered securities. The platform closed for 6 months to put its accounts in order and comply with securities regulation. The platform also raised the minimum credit score to 660,  considered to be a satisfactory credit score in the US.

The episode resulted in an industry led review on the business practices of almost all peer-to-peer lending platforms. The industry imposed rules on itself which raised the minimum credit score allowed, assessed the borrower’s capacity to repay their loan and used hard and soft information in order to categorise the borrowers into classes based on how safe an investment they are, and to set the interest rate according to this classification. These and other policies created a stricter investment criteria resulting in 1 in 10 loans being accepted by Lending Club,  1 in 5 being accepted at RateSetter, and similarly low acceptance rates at other platforms. The consequence is an overall default rate that currently is reported to be in the range of 0.2% to 7% depending on the platform.”

Source: Iosco Research Department

Source: Iosco Research Department

IOSCO Staff Working Paper. Crowd-funding: An Infant Industry Growing Fast

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