The Peer-to-Peer, or P2P, lending market has exploded in popularity over the past several years, doubling in size since the end of 2013. However, this young business still represents a tiny fraction of the overall consumer lending market. If P2P lending keeps growing at such an exponential rate, should banks start to worry?
What is P2P lending and why has it been so successful?
P2P lending is basically a form of lending where people loan money to each other through a company that acts as a facilitator.
For example, if you wanted to borrow $10,000, you could fill out an application with a peer-to-peer lender, and they would check your credit, employment, and other qualifications in order to assign you a "risk rating" and determine your interest rate. The company would then post your loan to its marketplace, where investors could decide to fund all or part of your loan. Once the loan is funded, you'll get your money and make payments to the P2P lending company, and they will pay the investors who funded your loan.
On the personal lending side of the business, companies like Lending Club (NYSE:LC) and Prosper have been the most successful, funding billions of dollars of loans in their short history as public companies. And, on the small business side of things are specialized companies such as Funding Circle, which has recently surpassed $1 billion in loan originations.
So, why has it been so successful? According to Sam Hodges, co-founder of Funding Circle, there is one main thing that sets P2P lending apart from banks. "The comment I hear most often is that our process is fast," said Hodges. "Getting a loan from a bank, particularly a business loan, can take several weeks or more. We can have the process done from start to finish within a week." Peer-to-peer lenders also pride themselves on being transparent -- there are no hidden fees and those fees that do exist are straightforward.
Basically, P2P lending has an advantage because it brings convenience and simplicity to a business that has far too little of either.
The future potential is limitless
Even after the surge in popularity, P2P lending makes up less than 0.1% of the overall consumer lending market in the United States. However, if it continues to explode in popularity like it has been, there could be a lot of room to grow.
For example, Funding Circle did about $500 million in loans in 2014, and Hodges says the company is currently on pace to do nearly double that amount this year. "I believe this business is still in the early stages of growth", said Hodges. "We're just starting to scratch the surface of the potential of P2P lending."
There has been substantial interest from private capital as well as from the investing public in P2P lending, and why not? The business model has relatively little risk for the companies themselves. The P2P lending companies simply collect an origination fee from the borrower when a loan is successfully funded, and an ongoing service fee from the investors for facilitating the transfer of payments from borrower to investor. The investors take all of the default risk, but they are compensated for this in the form of higher interest rates on their investments.
In a nutshell, P2P lending is an attractive business for all three parties involved, so at this point there is no telling how much interest there really is. However, I feel it is safe to say that there still are a significant amount of consumers who are unsatisfied with the loan options offered through banks.
Banks won't go away, but will begin to take notice
Let's be honest.The banking industry isn't going anywhere, and even the most optimistic P2P insiders concede that banks provide valuable services and will always have their place in society. However, even if P2P lending can manage to capture 1% to 2% of the overall lending market, you can bet that banks will begin to get worried.
I tend to think that the largest long-term effect of P2P lending will be that banks might have to overhaul their lending processes. If a significant portion of their business begins to look elsewhere for their borrowing needs because the alternative is faster, more convenient, and more transparent, banks will have a choice -- become fast, convenient, and transparent themselves, or give up a substantial portion of their potential customer base.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.