Big data drives marketplace lending
A common theme emerged at the Global Conference “Online Lending” panel, attended by leading marketplace lenders, including Lending Club, Prosper, OnDeck and Funding Circle. Data analytics— the ability to parse vast amounts of information in near-real time to develop credit profiles of consumers and small businesses— has been essential to the phenomenal growth rates seen in recent years.
Marketplace lenders have the unique ability to scour vast troves of online data to develop real-time debt calculations at speeds that traditional lenders can’t match. Prosper, for instance, looks at more than 400 data points in determining a borrower’s credit score, well beyond the scope of the FICO score. This, in turn, has vastly improved the customer experience in shopping for a loan and dramatically driven costs down, according to Jeff Bogan, head of Lending Club’s Institutional Group. As OnDeck CEO Noah Breslow quipped, “The FICO score is notoriously misleading.”
And banks themselves are increasingly giving a thumbs up to the data used by marketplace lenders to assess credit risk. As noted by panel moderator Amy Cortese, author of “Locavesting,” banks are not viewed as dinosaurs as much as viable partners. The flood of institutional investment into online lending platforms validates the credit scoring metrics marketplace lenders deploy, with data, technology and distribution driving the increasing number of partnerships with banks.
Apart from the expanded pool of institutional capital, these partnerships have also pushed online lenders to improve their compliance systems. While an apples-to-apples regulatory comparison between banks and online lenders may not be possible, in part because marketplace lenders do not take in FDIC-insured deposits, online lenders are still subject to a range of federal and state regulations, raising the barriers to entry for prospective alternative lenders.
Partnerships aside, marketplace lenders are also in demand outside the United States. While banking systems and regulatory structures vary from country to country, access to credit for small businesses is a universal problem. That’s made it easier for companies like OnDeck, which will launch in Australia this year, to move operations abroad.
Questions linger, however, as to how resilient the online lending model will be in the future. Lew Feldman, partner at Goodwin Procter, asked how online lenders can exist if credit markets tighten, with no liquid secondary market in place. While the U.S. and countries around the world are in record low interest-rate environments, which have contributed to the growth of online marketplace lenders, an economic downturn or rising rates could give the industry a run for its money. Will there be enough investor capital to fund originations? Will platforms continue to deliver high returns relative to the market?
A few panelists noted that over time, a robust secondary market would be beneficial, with diversification and stable capital sources important for sustainability. Data are also important in ensuring strong credit performance, while a focus on branding is critical to continued investment and trust in the sector.
It remains to be seen how large the marketplace lending industry will become and how resilient it will be to potential shocks. The Milken Institute will continue to monitor the FinTech sector and provide comments, where appropriate, to regulatory authorities on building an effective regulatory toolkit responsive to 21st century innovation.