With LendingClub's (NYSE: LC) highly anticipated IPO in the books and other similar companies gaining momentum at a breathtaking rate, I started thinking about the potential of this business model.
One thing is for certain: the peer-to-peer lending concept certainly has more room to grow. Investors in these companies may be handsomely rewarded, and the big banks may need to watch out.
The peer-to-peer lending business model used by LendingClub and other private companies like Funding Circle has a pretty basic concept. Basically, borrowers can apply for a loan and investors can purchase notes backed by the loans.
The business model has been so successful because this enables individuals and businesses to obtain loans they would not be able to qualify for otherwise, or they would have to pay much higher fees.
LendingClub provides unsecured personal loans to individuals, ranging from $1,000-$35,000, with interest rates ranging from about 6%-26% depending on the borrower's credit score and other qualifications. The company recently started issuing loans to small businesses, with loan amounts of up to $300,000.
Funding Circle has a similar business model, but is solely focused on lending to small businesses. The company makes loans to some business types considered very risky by many lenders, such as restaurants and retail businesses, and issues loans between $25,000-$500,000. From start to finish, the lending process generally takes less than two weeks.
With both companies, investors can buy the notes backed by the loans, and collect the interest paid by the borrowers minus a service fee (LendingClub charges 1% of borrowers' payments).
It's no secret that the idea behind peer-to-peer lending has really caught on, thanks to the hype surrounding LendingClub's IPO.
In fact, LendingClub has grown very swiftly for the past several years, and Funding Circle continues to break its own records for the amount of loans it issues per month.
According to Sam Hodges, Co-Founder & U.S. Managing Director of Funding Circle, getting the word out about this new lending option is a huge piece of the puzzle. The company's transparency about their fees and competitive interest rates speak for themselves, but many people simply don't know it is an option yet.
Could it hurt the banks' thriving lending businesses?
Despite the tremendous growth, peer-to-peer lending still makes up a relatively small portion of the personal and business lending market. LendingClub, the industry leader, has facilitated about $6 billion in loans and Funding Circle has lent about $750 million globally. While these are impressive numbers, they still pale in comparison to the loan portfolios of much of the banking industry.
In fact, the big banks have seen their lending operations grow considerably over the past several years. For example, Wells Fargo has about $839 billion in loans on its balance sheet, and JPMorgan Chase's isn't far behind at about $743 billion. In all, LendingClub estimates the consumer lending market to be about $3 trillion in size.
It's safe to say that if LendingClub, Funding Circle, and their peers remain a more attractive loan source than traditional banks as well as being an appealing choice for investors, the momentum in peer-to-peer lending should continue. And if it does, the big banks could see a significant portion of their lending business evaporate over the next several years.
Ultimately, borrowers could turn out to be the big winners here. If the peer-to-peer lenders start to really put a dent in the banks' business, we should see intensified competition among banks and peer-to-peer lenders, which hopefully means lower rates and fees for borrowers.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of JPMorgan Chase and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.