P2P Lending as Disruptive Innovation in the German Lending Sector

by Dirk Elsner on 24. August 2015

Heute mal etwas ungewöhnlicher für dieses Blog, einen Beitrag in englischer Sprache. Es ist das Transkription eines Gesprächs, das ich mit Kristin Krause* für ihre Masterarbeit geführt habe.

P2P Lending Market in Germany

Krisitin Krause (KK): Why did the market for P2P loans emerge? How big is the German P2P lending market? How similar is it to the US and the UK market?

Dirk Elsner (DE): Whether there is an emerged market in Germany, is not yet clear for me. Yes, there is a market and there are various platforms in Germany. They have relatively high growth rates, however on an extremely low level. But it is important to see the volume of P2P loans in relation to total lending in Germany. Based on data from the German central bank, I figured out through calculations that the emergency loan bad credit market does not even reach a percentage out of total lending. Thus, the significance of the P2P loan market is very low. Interesting is, which kind of numbers are published by the lending platforms. They sometimes provide numbers such as the total volume of contracts concluded on the platform, also in the past. It means that even repaid credits are still in the statistics. So before comparing numbers, it is important to know the data components.

Nevertheless, I believe that P2P loans are a very interesting opportunity for some companies and for private individuals. People, who are struggling to receive a loan, can find a good solution on a P2P platform. Struggling means not necessarily that they have a poor credit rating. In fact, it is much more the business segment of small loans that is not attractive for banks. Usually, commercial banks define their minimum amount of lending according to their costs. Anything below would not be profitable anymore. The small-loan lending business is more interesting for small innovative companies with new and highly automated technology. This creates a new alternative for people to borrower smaller amounts. Moreover, P2P lending platforms often can provide the service for lower costs than some commercial banks with a relatively complex lending process due to more manual steps.

KK: Which development of the P2P lending business in Germany do you expect?

 

DE: I expect that the P2P lending business in Germany will make further progress. Additionally, I assume that banks will put more emphasis on the P2P business model as they already do in the US and the UK. It should be especially interesting for them, because they could move some standardized lending business to external processors. There are several constellations conceivable such as collaborations between existing P2P lending platforms and banks or the development of new platforms operated by banks. By this, commercial banks could reduce their risk and at the same time their costs of equity and risk. Through sending customers to the platform, the bank would receive a commission without taking any risk. Regarding the regulation, it should not cause problems. It is rather helpful for banks in terms of risk and cost reduction and therefore really attractive.

KK: What major difficulties/challenges could exist in the German P2P lending market?

DE: First of all, there is the issue of regulation. P2P lending platforms are currently not or almost not regulated. Now there are some legal guidelines due to the laws for the protection of small investors (“Kleinanlegerschutzgesetz”). But I think that as soon as something really goes wrong beyond regular loan defaults, a regulatory framework for lending platforms will be created and established.

The second major topic, in my opinion, is the market penetration. The concept of P2P lending reached until now primarily young people and those who are open-minded for innovative solutions. Particularly for the traditional business in Germany, lending platforms are not yet a relevant opportunity. An important step to achieve the needed market penetration might be to become more professional regarding the public appearance of the platforms. In Germany, especially compared to US companies such as Lending Club, platforms chose a really playful marketing strategy, which does not attract professionals. It is not only the cheerful positioning, but also the limited information that is provided to the investors. The published data, specifically when compared to the US and UK platforms, could be improved a lot to attract more investors. To convince long-established members of the ‘Mittelstand’ to leave their local bank, the approach must be more reputable and reliable.

KK: Does a secondary market exist?

DE: As far as I know, there is no secondary market in Germany. There have been several attempts to found a secondary market, but those have not been successful.

KK: Do you have concerns regarding the risk distribution of the P2P loans?

DE: For the moment, the system seems to work well. If provided information turns out to be incorrect, it would cause public attention and serious concerns. For instance it might be possible that a borrower receives a very good credit rating, although there is critical negative information about him or her available. In such a situation, the lending platform would have a problem. When there is not enough or wrong information provided to the customers, then the platform would be responsible and not the investor who carries the rest of the risk. There are circumstances possible under which also the platform is liable. Basically, I think that the law of large numbers spreads the risk efficiently. Also a diversification strategy, that every investor can choose, can lower the risk. Lending Club published statistics that investors should allocate their resources ideally to at least 100 different notes. This recommendation is interesting, because it does not seem to represent the dimensions of the typical small investor anymore. However, investors still have to be aware of the fact that a platform does not carry the risk as banks would do.

KK: How do you assess the possibilities of moral hazard on lending platforms?

DE: I think that the risk of moral hazard always exists. Nevertheless, the probability that it occurs in the WWW is higher than in the real life of face-to-face banking business, because of lower psychological barriers. Though the question is whether such credit requests do reach the P2P platform at all. Lending Club stated that the checking mechanisms only grant 10 percent of all credit applications access to the platform and the funds of investors. The tight quality criteria show the importance of the issue.

German Banking Sector

KK: Why did not banks already join the P2P market segment of borrowing?

DE: My perspective is that banks devote their energy mainly to the standardized processes and products. So they don’t realize the opportunity. Moreover, it seems like they do not understand the P2P lending concept as a business strategy with its advantages. Based on statements of management members, this is a logical conclusion for the German market. In contrast to that, British banks have a different perspective. Due to regulation, they have to refer to P2P lending platforms, if they cannot provide a loan for their customer.

KK: How are banks affected by the P2P lending business?

DE: Currently, German banks are almost not affected by the P2P lending business. Platforms are not perceived to be competition. They will only gain importance for credit institutions, when they achieve a relevant magnitude compared to banks.

KK: Can banks offer the same types of P2P loans? Why are banks not offering loans to the customers that the P2P lending companies provide?

Yes, I think they could offer such P2P loans. Banks could either collaborate with an existing P2P lending company or set up their own platform. Actually, the conception of P2P loans is equal to the structure of bonds. Commercial banks in Germany underwrite securities and therefore they already have the capabilities and skills to offer P2P loans. The main difference is the size of the contracts. P2P lending is the highly automated processing of much smaller loans than the traditional bond issuance. I believe that banks do not consider it to be an interesting business model at the moment and they do not recognize the attractiveness as a business segment. I cannot rationally explain why they do not take advantage of the opportunity.

KK: How do banks react to the appearance of P2P lending platforms and how should they react?

DE: Although major banks do not react yet, there are a few cautious attempts to start collaborations. One example is the Fidor Bank in Munich. That institution offers its customers the opportunity to invest in P2P loans via the online banking account. Therefore, P2P loans became an extension of the product portfolio of the bank. In addition, it is easier for the clients because they do not have to register on the P2P lending platform. But in my opinion, commercial banks should start a large-scale offensive to enter the P2P lending market. Especially the big ones should take the chance and start large campaigns. Joining this business segment, banks would receive a new risk management tool which also has positive effects on their costs. Moreover, banks and platforms, in case of collaborations, could benefit from commission revenues. But I think for the German market to take off, one big commercial bank has to start and then others will follow.

Lending Platforms vs. Credit Institutions

KK: How would you categorize the P2P lending companies: are they competitors or potential investment opportunities for credit institutions?

DE: Currently, German banks do not perceive P2P lending platforms to be relevant competition. In the US and the UK, they start to realize the potentials. Almost the same is true for the perception as investment opportunity. In Germany, credit institutions seem to be neither interested in buying P2P lending companies nor in investing in projects on the platforms. However, the bank clients might be attracted by P2P platforms. According to this also banks should show interest at some point. If customers like the idea of investing in P2P loans and address themselves to their local bank to get more information, banks will be pushed to that direction. Especially institutional clients and asset managers might be inspired by interesting returns in a low-interest phase of the economy.

KK: Are the P2P lending customers lost customers from the commercial banks?

DE: Regarding the loan section, it is definitely possible. If customers have good experiences with P2P loans, they probably will continue to borrow via lending platforms. The investor perspective can be similar. Satisfying returns and smooth procedures trigger further investments. Nevertheless, this does not mean that they lose the entire business relationship with those customers. They may only lose the customers regarding the specific credit or asset class.

KK: Where do you expect the P2P and the traditional lending market to be in 5 years from now?

DE: In Germany, I expect the P2P lending market to reach a volume of five to ten billion Euros in five years. This would be still not a relevant portion of the lending market. For the US, there have been forecasts published of 50 to 100 billion USD. I cannot say whether this is a realistic prediction for the US market or not, but it is imaginable.

Regulation

KK: Under which regulatory framework does the P2P lending market adhere also in comparison to commercial banks?

DE: There are several regulatory frameworks that are significant here. The Banking Act (“Kreditwesengesetz”) is relevant for any entity that offers professional lending. Then there are investor-protection regulations, in particular the Retail Investors Protection Act which again contains a range of policies. Changes of the policies are currently in progress that will be important for the investment aspect of the P2P.

The major banking regulations such as Basel II and III do not affect P2P loans. Those frameworks comprise equity, risk and liquidity provisions that do not relate to platforms. This is why the concept is so interesting for banks by using P2P platforms they can complement their portfolios strategically. Country-specific provisions such as the stricter requirements for investors in the US are also crucial. Potential investors have to fulfill much more requirements in the US than in Germany.

KK: How is the P2P market regulated and which ones are the requirements for P2P companies?

DE: Usually, P2P platforms such as Auxmoney, Smava or Rocket Internet are structured that way that they are connected to a partner bank. The platform is responsible for the technological components. Meanwhile, the bank meets the requirements of financial regulation, but remains in the background. This is important because for a “legal second”, a bank loan is granted. Since the bank provides the legal support, the P2P lending platform is not inevitably tied to the regulation. Nonetheless, the bank usually requires the platform to devote itself to some standards in exchange for serving as regulatory cover.

KK: Which additional regulatory requirements will most certainly arise in the near future for P2P lending platforms?

DE: Modifications of the Retail Investors Protection Act and the reform of the Markets and Financial Instruments Directive (Mifid II) are currently in progress. Those target the protection of investors as well as required reporting. Hence, also P2P lending platforms should already be affected by the modifications even though not to the same extent as banks.

KK: Can the P2P lending market be forced to adhere to similar capital requirements as the commercial banks?

DE: No, I do not believe that this could happen. Probably there will be requirements for P2P lending platforms in the future. But it does not make sense to impose the same capital requirements on P2P lending platforms as they exist for commercial banks. The capital requirements for banks intend to ensure the necessary stability to carry the risk they take. In contrast to the liability of banks, the P2P lending model passes the risk on to the investors. Consequently, they do not have to back any risk with own funds.

Conclusion

KK: Do you consider P2P lending platforms to be a disruptive innovation for the German lending industry?

DE: I do not consider P2P lending to be a disruptive innovation. In abstract terms, the model does already exist in the banking industry for a long time. Concepts such as Bitcoin or Blockchain have disruptive characteristics in my opinion, but not P2P lending. I do not perceive it to be disruptive, because I don’t think that P2P lending will eliminate the traditional lending business. Though for US, UK and Asian markets, I see more potential than in Germany. The German customers often take a bit longer to adopt new methods, in particular when it concerns a sensitive topic like money. But I think the German market will grow further as soon as one bank starts to push the P2P model offensively forward. If one bank is successful, then others will follow the trend.

Comparison of Lending Platforms and Credit Institutions

Perspective of the Borrower:

 

    • Costs: When we sum it up, the costs are probably on the same level for both.
    • Risk: The borrower does not really carry any risk either way, there is no difference between platform and credit institution here.
    • Service and consulting level: Banks are the better consultants, but regarding the service, platforms are better because they are faster and more transparent.
    • Data privacy and security: Here, banks are much better because of the immense efforts they invested in data security.
    • Entry barrier/requirements to receive the funds (accessibility): Entry barriers of the platforms are lower than the ones of banks. It is easier to get access to funds via platforms because the probability to find a lender while having a poor credit standing is higher. Platforms are less constrained.
    • Flexibility (exit options): Both parties have an equal standing here, because both entities have standardized processes. For small loans, there is not much room for individual negotiations. The systems offer loans to customers that comply with the parameterized factors. As banks offer face-to-face meetings, they may even have a small advantage here.
    • Level of Customization: The standardization does not allow deviations. For small-scale lending, there is not much room to move for customization included.
    • For the borrower perspective it is difficult to decide which criteria is the most important. Apart from indicating the importance of costs, I do not state specific weights.

 

Perspective of the Investor:

 

    • Return: Platforms yield higher returns than the usual average investment opportunities.
    • Risk: In case of diversification, the risk is lower because it is spread over the different assets. But in case of investing the whole sum into one P2P loan, the risk is much higher than the risk of average investments. The risk level depends on diversification.
    • Service and consulting level including legal advice in case of default: Compared to the bank advisor, the level of platforms is lower.
    • Costs/efforts necessary to invest: The platforms’ costs are lower.
    • Availability and quality of information: It depends on the specific lending platform. Some excel compared to banks and some are worse. For example Lending Club provides outstanding information to investors. The availability and quality of the reporting is excellent and much better than the majority of banks, I think. But this would not be true for other platforms, especially in the German market.
    • Availability/accessibility of investment opportunities: Here also some platforms are better than banks, but not all of them.
    • Flexibility (exit options): A secondary market is here a significant aspect. If customers buy tradable shares, then the flexibility is much higher than the liquidity of P2P loans. But this question depends on the asset classes that are analyzed.
    • Level of Customization: Also investors have to adapt themselves to the standards of the companies. As long as they are no large-scale investors, there is no opportunity to interfere.
    • As investor, I would focus on return, risk and the availability as well as quality of the provided information.
    • This analysis shows that it is not that attractive for borrowers to use P2P platforms, instead it is much more interesting for investors.

 

 


Kristin Krause ist seit Juli zurück in Deutschland und wohnt in Hannover. Zuvor hat sie für ein Jahr in Paris gelebt und dort an der Paris School of Business (Teil der französischen ESG Hochschulgruppe) das Programm des International MBAs absolviert. Sie hat sich den Schwerpunkt Finance ausgesucht, der alles, was mit Kapitalmärkten zu tun hat, einbezieht (Accounting, Financial Markets, Derivatives, Investment Banking, Legal Frameworks, Currencies, usw.). Zuvor hat sie im dualen Studium (Bachelor in BWL) bei der NORD/LB Praxiserfahrung gesammelt.

 

UK tax advice September 8, 2015 um 19:12 Uhr

Bookkeseping is an imporrtant work for small to large business and newed extra attempt andd care.
And, finally, describe the impact of thhe problem
onn thee lives off those affected. Yoou have to use those numbers
to tell thee owner of a business, shareholder, bank, oor
manager what they mean; how they can use them; and what to expect inn the future.

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