In 2020 Russia will see the birth of investment platforms, which are financial organizations of a new type. Through them, individuals and companies can secure loans directly from investors. However, in the majority of countries they are not subject to financial regulation.
  |   Sergey Moiseev

The first P2P (peer-to-peer) online lending platform,  Zopa, was launched in the UK in 2005. P2P loans excluded financial intermediaries from borrower-investor relationships. In the USA the first P2P platform, Prosper Marketplace, appeared in 2006. Both companies deal with non-collateralized loans. The last 10 years have seen an online lending boom, driven by such platforms. In some markets, online loans have gained significance as a source of alternative loan supply. A typical example is the UK where online platforms account for more than one-fourth of new loans to small enterprises. The Swedish Riksbank  estimates that the volume of the online lending market has reached $6bn in the UK, $33bn in the US, and $323bn in China. The volume of outstanding loans issued by LUp2p, a leading Chinese online lender, exceeds $21bn. The  report of the Cambridge Centre for Alternative Finance argues that China accounts for more than three-fourths of all P2P loans. The number of P2P platforms in China exceeds 3,000, and they are gradually shifting their focus from individuals to small enterprises and large corporations.

The volume of online loans is still much smaller than that of bank loans, but it is growing fast. The world’s largest platforms—the US LendingClub and Prosper, and the UK Funding Circle—are open to retail and institutional investors and form borrower and investor pools. In recent years, e-commerce platforms like the US Amazon and Chinese Alibaba have also started offering non-bank loans to their suppliers and customers.

Bank competitors

Technological edge is the key to the success of platforms. In terms of supply, this means user-friendly interfaces, 24-hour accessibility, and easy and fast loan application. In terms of demand, the success of online lending platforms is determined by the borrower profile: usually, they do not have any collateral, their bank lending options are limited, their borrowing capacity is poor, and they have no credit history.

At first, online platforms targeted subprime borrowers, i.e. those who have no access to bank lending or who cannot afford it. However, having started with non-collateralized loans, platforms later widened their target market by offering student loans, car loans, mortgages, and SME loans. Online loans  can substitute a significant fraction of individual bank loans to current bank borrowers. 

Online platforms flourish because of their competitive edge and lack of regulation. P2P platforms do not need to maintain a costly branch network or a system of servers and data centers in compliance with operational risk management requirements. Online platforms rely on simple web solutions, external call centers, automatic credit risk evaluation, and cloud computing software. They do not have reserve requirements to meet, obligatory deposit insurance contributions to make or other regulatory expenses to cover.

Crowdlending in Russia

On 1 January 2020, a new  law on crowdfunding via online platforms is coming into effect. The Bank of Russia will maintain a register of investment platform operators. Each operator should meet a minimum capital requirement of 5 million roubles, report to the Bank of Russia, manage conflicts of interests and disclose full information. This is the exhaustive list of prudential regulatory requirements for online platforms. The law permits online lending only to Russian entities and individual entrepreneurs, while individuals can act as investors. In 2020 30 online platforms are expected to become official. Most of them are already active and specialize in lending; legal innovations, such as offering securities or tokens (which are called utilitarian digital rights), are not yet popular. In July 2018 four companies founded the  Association of Investment Platform Operators to unite players in the crowdfunding market.

The platforms estimate their market volume at about 10 billion roubles. In 2019 it is estimated to have shrunk by half, to 5 billion roubles, as the result of a regional bank’s activities. To conceal its financial standing, the bank reported its loans as claims on its affiliated platform, but the revocation of its license, which followed soon, excluded its loan data from the overall platform data and, consequently, reduced the estimated volume of the online lending market.

Overdue loans account for no more than 30-40% of the P2P platform portfolio and no more than 20-30% of the P2B portfolio, which makes the business model for online-lending platforms similar to that of microcredit or microfinance entities, i.e. short-term loans to subprime borrowers that have no access to bank lending. Given the lack of prudential regulation, microfinance organizations will be tempted to switch to the online lending market. Even now most of the entities which have applied for status as online platforms have people with a microfinance or banking background as their founders.

Although many major banks are developing their own platforms, Sberbank is the only one to have announced it publicly. The media argues that the SberKredo platform is designed to attract funds from individuals and allocate them to Sberbank’s corporate borrowers in the form of co-financing loans. In 2018, Sberbank established OOO Tekhnologii kreditovaniia with the capital of 100 million roubles to service its platform; the director of Vydaiushchiesia kredity, a microcredit entity owned by Sberbank, became the head of the new company. Despite having their own R&D projects, other banks are just weighing the opportunity. Generally speaking, the potential size of the online lending market is apparently limited by the size of the microfinance market and its ceiling for growth is 100-150 billion roubles, which accounts for 0.3-0.4% of loans extended to non-financial entities. Thus, online platforms are unlikely competitors for banks, while the lack of prudential regulation may allow them to generate double-digit annual growth.

Regulation: present and future

Every financial regulator has to maintain a balance between two policies: it aims to minimize risks to financial stability on the one hand and to create a legal and regulatory framework for implementing innovations and testing new business models on the other. When the online lending market is small, the regulator favors a softer approach. New players are obliged to comply with the standards of consumer and investor protection, with special attention being paid to disclosure requirements.

For instance, in May 2016 a scandal involving the LendingClub platform erupted in the USA. The platform had been providing its institutional investors with false information while concealing the conflict of interests facing its management. The U.S. Securities and Exchange Commission  accused LendingClub Asset Management and its CEO Renaud Laplanche of fraud. The fund and its management were fined and Mr. Laplanche was banned from working on the stock market. As loan supply grows and financial risks increase, all markets face stricter regulation, which often deals with non-banking financial intermediation or shadow banking. The development of the market will inevitably bring prudential problems to the forefront. For example, in 2015 the Swedish platform Trustbuddy went bankrupt after turning out to have been a Ponzi scheme. Since its foundation in 2010 and to its bankruptcy in 2015 Trustbuddy had allocated almost one-fourth of the raised investment capital (23%) to bad loans. Some of the money received from new lenders was paid to existing investors, to whom Trustbuddy had promised double-digit returns. When the Swedish Financial Supervisory Authority initiated  involuntary bankruptcy proceedings, the number of wronged investors had reached 3,500. Unclear property rights to loan repayment claims and the lack of a legal framework for settling claims against the platform itself made the bankruptcy proceedings more complicated. Now, online loans are outside the financial regulatory framework in most of the jurisdictions of the world. For example, the European Union has no legal framework regulating the new phenomenon, although, in 2018 the European Commission acknowledged the need for it. As a result, lending platforms are not included in deposit insurance systems. In some countries, such as Germany and the USA, only banks are allowed to issue loans. As a rule, small specialized banks outsource front office tasks to online platforms. In other words, banks do not assume credit risks, but rather make payments to borrowers. In other jurisdictions, lending platforms can receive licenses for various forms of activity. For example, they can operate as loan brokers, payment systems or non-bank investment intermediaries.

The Cambridge Centre for Alternative Finance  estimates that only 22% of jurisdictions regulate P2P lending. Such lending is mostly regulated by special laws and regulations. The most benchmarked-against jurisdictions are the UK, the USA, and Singapore. Most regulators are optimistic about the potential of online lending, which can improve small enterprises’ access to finance and support financial competition.

Expectations define future policies: in the short run, only a third intend to regulate P2P lending. Thus, in the upcoming years, online loans will still enjoy favorable conditions. Given the novelty of the phenomenon, a special financial framework might emerge when both regulators and the platforms themselves gain market experience.