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Marketplace Lending: A Maturing Market Means New Partner Models, Business Opportunities

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In the financial services industry, marketplace lending, also known as P2P lending, initially focused on online lending and borrowing as an alternative to traditional banking systems. Today, …

In the financial services industry, marketplace lending, also known as P2P lending, initially focused on online lending and borrowing as an alternative to traditional banking systems. Today, conventional banks, other financial institutions and institutional investors are looking at these platforms as a way to realize better returns and diversify their portfolios. To take advantage of this opportunity, marketplace lenders must focus more on security, venture into areas like remittances, understand the preferences of target users and reasons for default, and form viable partnerships with conventional banking institutions.

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  • 1. Marketplace Lending: A Maturing Market Means New Partner Models, Business Opportunities To maintain their impressive growth, marketplace lending platforms should focus on providing greater security for investments and transactions, venture into areas such as remittances, and set up viable partnerships with traditional banks and financial institutions. cognizant reports | July 2014 • Cognizant Reports
  • 2. cognizant reports 2 Executive Summary Since the early 1990s, when the Internet and online commerce began to take shape, peer-to- peer (P2P) transactional systems have contin- ued to evolve. Much like the Internet, they have morphed from highly centralized, static online platforms to widely distributed, autonomous systems that span the spectrum — from B2B and B2C commerce (Amazon.com), to legal deal- ings (compliance and reporting, loans) to music (Napster) and online auction platforms such as eBay. Needless to say, these pioneers have radically changed how businesses and consumers act, interact, buy, sell and service over the Net. In the financial services industry, P2P first emer- ged in 2005 – focusing on lending and borrowing. P2P lending platforms, also known as market- place lending platforms, offered an alternative to traditional banking and payment systems, since they cater to the underserved with services like consumer lending, student loans, real estate and small-business lending markets. While these online providers create a marketplace for lend- ers and borrowers, lenders expect a higher rate of return on their investments compared with simple transactions such as bank deposits. Borro- wers who are unable to qualify for loans from banks turn to these alternatives to obtain credit — possibly at a lower interest rate than they would have received from their bank, based on their respective credit profiles. Traditional banks, which until recently remained confident about their ever-increasing spreads, are now paying close attention to these previ- ously unconventional platforms. Lending Club and Prosper, the two largest marketplace lend- ers in the U.S., issued US$2.4 billion in loans in 2013. In 2012, they issued US$871 million in loans.1 These figures point to the impressive growth of marketplace lenders. The apparent success of this approach is now prompting banks to enter into partnerships with digital lending marketplaces. Other financial institutions and institutional investors are also actively investing in market- place lending platforms to realize better returns and diversify the risk profile of their portfolios. However, to realize the potential of this opportu- nity (estimated to reach US$1 trillion by 2025),2 marketplace lending platforms need to better comprehend the choices and preferences of their target users by analyzing the mas- sive quantities of data in the digital market. They also need to understand the types of loans that borrowers/lenders are interested in, as well as the factors driving default rates. To deepen our understanding of marketplace lending dynamics, we conducted a detailed study in the U.S. — surveying both borrowers and lenders across a wide array of marketplace lending com- panies, age groups and income categories. The survey was conducted online among a nationally representative sample of approximately 11,000 U.S. consumers — roughly 701 of whom are market- place lenders or borrowers — during February and March of 2014 (see our detailed methodology on page 15). Our goal was to capture emerging trends, as well as the current and future needs of lend- ers and borrowers, to help organizations increase the uptake of marketplace lending services. The study identified distinct sets of financial and social characteristics of borrowers. These attri- butes can serve as a benchmark when making lending decisions. From our findings, we recommend that market- place lending companies focus on vehicle and small business loans, and provide more options for lenders to analyze loans. They should consider both financial and social factors while categorizing loans. Marketplace lending busi- nesses should also partner with banks to leverage those institutions’ large branch networks. Taking the Pulse of Marketplace Lending: Key Findings Our research also revealed the key challenges that marketplace lending companies should address, as well as features and functions that must be developed to create a more prosperous, more mutually beneficial marketplace: • Marketplace lenders: » Believe that lending through marketplace platforms is risky, but are attracted by the solid rate of returns, which range from 7% to 24% per annum. » Would be willing to lend more often if they were provided with options such as imme- diate liquidity of funded loans, securing a part of the principal through insurance, updates on the borrower’s repayment track record and, importantly, if the marketplace platform was allied with traditional banks.
  • 3. cognizant reports 3 » Desire provisions for bad debts and legal action against defaulters. » Are willing to extend domestic money transfer/international remittance based on the borrower’s credit scores or per- sonal guarantee. They believe that the receiver of the money will repay the loan. This can be a potential business model for cross-border remittance companies. • Marketplace borrowers: » Seek lower interest rates compared with banks, the opportunity to obtain loans despite a poor credit rating, and a quick and easy approval process. » Need physical branches and opportu- nities for enhancing interactions with lenders through the digital platform. The Current State of Marketplace Lending such as eBay’s role in creating a so-called “per- fect marketplace” where all parties operate on equal footing by negotiating mutually acceptable terms and conditions. As such, online auctions have emerged as an effective “market mecha- nism” for arriving at the correct value of an item. Like its P2P predecessors, marketplace lending bypasses the traditional intermediary — the bank — by directly connecting borrowers with lenders through digital platforms. The focus is primarily on small loans, such as those related to credit card debt. Marketplace lending platforms typi- cally use proprietary algorithms to assess risk, creditworthiness and interest rates. These platforms have emerged to address latent market demand for loans from borrowers who are creditworthy but unable to qualify for loans from traditional banks – the reasons being as varied as relatively low FICO scores, no current income, and banks’ outdated credit scoring models. Interest in marketplace services has also been fueled by lend- ers looking for more attractive returns on their Marketplace Lending: Market Composition Figure 1 Response Base: 701 N=701 Borrowers 39% Lenders 37% 24% Marketplace Lending’s Initial Headwinds The early days of marketplace lending were marked by turbulence. In 2008, the Securities and Exchange Commission (SEC) sent a cease and desist letter to Prosper for selling unregistered securities. This led to a legal precedent that specifies that marketplace loans must be registered securities. As a result, numerous marketplace lending companies shut down. Loanio is a case in point. The business worked on obtaining SEC registration after setting up just seven loans. All the loans defaulted, and Loanio was unable to obtain any venture capital.3 Compliance with SEC regulations is a costly affair. For example, Prosper is spending US$1million annually on compliance, and spent US$5 million to complete the registration process.4 An analysis of the UK marketplace lending industry reveals that 35 marketplace lending companies have launched since 2005. Of these, 10 have shut down due to high default rates — a staggering 28% of the total.5 Another 10 companies were launched after May 2013. This suggests that an equal percentage of marketplace lending companies do not have a long enough track record to make a judgment about the quality of loans they generate. Quick Take Our research revealed key dynamics of market- place lending. For instance, there is a group of customers (24%) who borrow as well as lend on marketplace platforms (see Figure 1) at different points in time. Traditionally, online markets have delivered oper- ational efficiency and transformed businesses by bringing together buyers and sellers on an unprecedented scale. Success stories abound,
  • 4. cognizant reports 4 investment from alternative sources. Nevertheless, despite its initial promise, the market has devel- oped in fits and starts (see sidebar, previous page). Although there is untapped demand for loans in the market, there are inherent risks in any lender-borrower relationship. The major expo- sure in marketplace lending is loan default, which can erode the lender’s return on investment and cut into the principal. Lenders therefore need to understand the reasons for default. Reasons for Defaults The main reasons for defaults, according to the lenders we surveyed, are unexpected expenses, disruption in the borrower’s earnings due to loss of job or business, and lack of collateral security and personal guarantees (see Figure 2, above). Defaults reduce the creditworthiness of borrow- ers. Receiving a future loan becomes next to impossible; even if they receive a loan, borrow- ers have to pay very high interest rates. Also, they become part of the lowest category of loan seekers. With this in mind, borrowers should do their utmost not to default, especially if they per- ceive the need for another loan. Borrowers cited maintaining a good reputation with the lending community, values and honor, and preserving creditworthiness as reasons for not defaulting. The default rate is also an important yardstick for measuring the performance of a marketplace lending platform. According to Prosper, a leading marketplace player, its default rates range from 1.55% for the best-rated borrowers, to 16.7% for its lowest-rated.6 However, during the recent economic recession, Prosper’s default rates peaked at 30%. Apart from the risk of default, lenders also fear the lending platform going bankrupt. These platforms do not have the government backing that banks seem to have. Lenders still trust the banks – an incentive for banks to enter the marketplace lending arena. Traditional Banks Enter the Marketplace Lending Arena Reasons for Defaulting—Lenders’ Views Figure 2 Response Base: 349 Agree Strongly Agree 42% 43% 48% 40% 52% 42% 46% 26% 26% 23% 32% 21% 33% 30% 37% 26%No legal action against default borrowers 43% 23%Lack of regulatory policies 43% 23% Accountability is low among young and unmarried borrowers Repayment largely depends on loan terms Repayment for the most part depends on interest rates and closing fees Defaults occur due to lack of collateral security or personal guarantees Repayment mostly depends on loan amount Repayment largely depends on loan type/purpose of loan Disruption to borrower’s earnings or income Unexpected expenses Willingness to Lend on Marketplace Platforms Run by Retail Banks Figure 3 Response Base: 349 Yes No 26% 74%260 89 Yes No In March 2014, the venture capital arm of Westpac, one of Australia's largest banks and the second- largest in New Zealand, invested US$8.5 million in SocietyOne, Australia's leading marketplace lending platform. The bank was among the first to directly invest in the marketplace space. At the same time, Barclays Africa acquired a 49% stake in the marketplace lending platform RainFin.7 More recently, Lending Club announced a tie-up with Union Bank. These investments speak for themselves – telling us that banks are seriously interested in marketplace lending.
  • 5. cognizant reports 5 Likewise, individual lenders are keen on lending on marketplace platforms run by retail banks. According to our survey, 74% of respondents were willing to trust platforms run by retail banks (see Figure 3, previous page). This might be due to individual lenders’ long-standing relationship with these institutions. Banks with their own marketplace lending plat- forms can choose to pass on certain loans to the latter. Lenders who find marketplace lending inherently risky (see Figure 4) would also be attracted if the big banks were to get involved. Borrowers, on the other hand, have expressed a desire to interact with lenders. They also indicated they would like marketplace lending businesses to offer physical branches (see Figure 5). Both of these needs can be fulfilled when marketplace lending services affiliate with banks. Banks have a large physical network of branches; they can also help to facilitate face-to-face interactions between borrowers and lenders. Risks of Lending on Marketplace Platforms Compared with Other Types of Commercial Lending Figure 4 Response Base: 349 A full 47% of lenders indicate that marketplace lending is risky. The major reasons are lack of trust in borrowers, lack of security of investments and absence of government support. Risk of lending on marketplace platform compared to other types of commericial lending. High No Difference Low 26% 27%47% Borrowers' Priorities for a Marketplace Platform Figure 5 Response Base: 352 ThirdFeature Priorities: Second First Branch availability for marketplace lending 26% 20% 43% Lender and borrower interaction 27% 17% 39% Partnering with traditional banks 23% 30% 10% 24% 34% 9% Online tools for portfolio analysis, risk calculation, etc. When banks enter the marketplace lending space, can institutional investors be far behind? Probably not. These stakeholders have already shown interest in marketplace lending. More than 80% of the loans issued by Prosper in March 2014 were funded by institutional investors. Furthermore, at least a dozen invest- ment funds have been formed with the sole intent of investing in marketplace loans.8 This suggests that the financial institutions that marketplace platforms set out to bypass are now investing in them. Institutional investors are attracted by better returns, and the relative stability and short duration of the loans. They are also securitizing marketplace loans and selling them to other investors. In September 2013, Eaglewood Capital sold a US$53 million securitization of marketplace loans from Lending Club to investors.9 Other banks are exploring ways to securitize marketplace loans into large bundles that can then be sold to sizable investors. Institutional investors are finding other ways to gain an advantage in this space. In some cases they have set up servers near the marketplace lender’s premises to get a head start and provide funding quickly, before other lenders. This tactic resembles those of high-frequency traders, who depend on speed for higher returns. In response, Lending Club has set up “speed bumps” to limit institutional buying.
  • 6. cognizant reports 6 In May 2014, Lending Club announced a strate- gic alliance with Union Bank. Initially, the bank will purchase personal loans through the plat- form; later, the two will join to create new credit products for customers. Prosper also raised US$70 million in venture capital in May 2014. With so many institutions putting a stake in the ground, the industry looks more and more like online consumer lending. Borrowers’ Classification11 Based on Credibility Figure 6 Response Base: 352 Note: The size of the bubble reflects the number of respondents in that group. The figures inside or outside the bubbles indicate the percentage of respondents belonging to that group. Low High Least Most Borrowers’Credibility Preference Disinclined 9% Inclined 11% Prudent 59% Abider 21% Factors Underlying Marketplace Lending Decisions Lending decisions are tough. This is especially true in marketplace lending because the lender has the freedom to choose the loans they want to fund. To help zero in on the major factors impacting lending decisions, we identified social and finan- cial variables as predictors. The social variables represent peer group members’ ratings and marketplace lenders’ endorsements. The financial variables include the borrower’s annual income, debt-to-income ratio and credit rating. Our statistical model10 indicates that a borrower’s annual income and credit rating are the significant So will the retail investor be left with any loans to fund? We believe there is space for both institu- tional and retail investors. Individual investors can choose from the fractional loans on offer because institutional investors would prefer whole loans. We also believe marketplace lending platforms must maintain a balance between retail and insti- tutional investors to strengthen their position in the industry. Quick Take predictors of default. Figure 6 presents bor- rower groups based on borrower credibility. A borrower’s credibility is determined by his annual income, debt-to-income ratio, credit rating, peer group members’ ratings, and marketplace lenders’ endorsements. The “abider” group of borrowers is the most preferred. The “prudent” group of borrowers has the highest number of respondents and is the second most preferred. The “inclined” and “disinclined” groups carry the highest risk of default. Each of these groups has a distinct set of characteristics (see Figure 7, next page). These characteristics can serve as a benchmark when making lending decisions.
  • 7. cognizant reports 7 The Lure of Marketplace Lending Platforms Characteristics of Different Groups Group Characteristics Abider • Rated very highly by peer group members (excellent). • Strongly recommended by previous marketplace lenders (excellent). • Debt-to-income ratio is less than 36%. • Credit scores are above 720. • Annual income levels above US$100,000. Prudent • Rated highly by peer group members (good). • Recommended by previous marketplace lenders (good). • Debt-to-income ratio between 37%–42%. • Credit scores between 660 and 720. • Annual income levels between US$50,000 and US$100,000. Inclined • Rated “fair” by peer group members. • Least recommended by previous marketplace lenders (fair). • Debt-to-income ratio between 43% to 49%. • Credit scores between 600 and 660. • Annual income levels between US$30,000 and US$50,000. Disinclined • Rated “poor” by peer group members. • Not recommended by previous marketplace lenders (poor). • Debt-to-income ratio above 50%. • Credit scores less than 600. • Annual income levels less than US$30,000. Figure 7 Reasons for Marketplace Borrowing Figure 8 Response Base: 352 Home improvement 30%107 104 Repaying debt 30%104 Paying bills (credit card, utilities bill, etc.) 38%132 Figure 9 Response Base: 352 Comparison of Lending Institutions’ Loan Approval Rates 81% 66% 59% 54% 44% 40% 15% 26% 32% 33% 48% 39% Marketplace Lending Sites Credit Card Family/Friends Credit Unions Traditional Banks Housing Societies Approved Rejected Individuals use marketplace lending platforms primarily to borrow money to pay bills (see Figure 8). The other common reasons are home improvement and repaying debt. Borrowers typically turn to marketplace lending sites as a result of their high approval rates compared with other sources. Among those we surveyed, 81% of loan applications were accepted by marketplace lending sites versus 44% by traditional banks (see Figure 9, below).
  • 8. cognizant reports 8 Borrowers’ Wish List Borrowers want physical branches and more interaction between borrowers and lenders (see Figure 10). Borrowers have also shown an inclination to bor- row for the long term to buy a vehicle or a house against collateral (see Figure 12). Borrowers’ Recommendations Figure 11 Response Base: 352 Virtual interview with potential lenders 12%42 Looking beyond just credit history, current income and debt 31%108 One-time approval process 32%113 Short, well-written questions 33%117 Quick approval 67%235 Willingness to Borrow for the Long Term (Beyond Five Years) for Buying Vehicle/House 26% 66%Yes 8%No No collateral Against collateral No Figure 12 Response Base: 352 64% Very Much 226 28% Somewhat 98 8% Not At All 28 Willingness to Borrow As a Group Figure 13 Response Base: 352 82% Fine 289 14% Not Fine 51 3% Don’t Have An Account 12 Willingness to Share Social Media Profiles Figure 14 Response Base: 352 Borrowers are amenable to subjecting their social media profiles to scrutiny; 82% have shown a willingness to share their social media profiles (see Figure 14). Features Sought by Borrowers Figure 10 Response Base: 352 24% 34% 9% 26% 20% 43%Branch availability of marketplace lending site 27% 17% 39%Lender-borrower interaction 23% 30% 10%Partnering with traditional banks Online tools for portfolio analysis, risk calculation, etc. Third Second First The availability of online tools such as calculators to compare interest rates across marketplace platforms is also very important to borrowers. They also seek quick online approval of loan requests, a simple registration flow, and a one-step approval process (see Figure 11). Some marketplace lenders require cars as col- lateral.12 The car can cover any percentage of the loan amount, not necessarily the full amount. The borrower needs to deposit the certificate of ownership with the marketplace platform. Borrowers are even willing to borrow in groups and be jointly responsible13 for all the loans (see Figure 13). This can lead to lower default rates – in some cases the result of perceived peer pressure.
  • 9. cognizant reports 9 Influencing Friends and Others to Join the Peer Group Figure 15 Response Base: 352 No Yes Recommending Friends & Others 88% 12% Importance of Data Privacy and Security of Marketplace Lending Sites Figure 16 Response Base: 701 Somewhat Important Important Highly Important 3% 36% 61% Data Privacy & Security Features The importance of data privacy and security fea- tures can be gauged by the fact that almost 77% of borrowers and lenders are willing to pay a nom- inal fee for additional biometric security features (see Figure 18). Willingness to Adopt Biometric Security Features for Marketplace Transactions Figure 17 Response Base: 701 Yes No 87% 13% Preferred Biometric Authentication Method for Marketplace Transactions Figure 19 Response Base: 701 Others Fingerprint Matching Voice Recognition Facial Recognition 26% 27% 47% Willingness to Pay for Biometric Security Features Figure 18 Response Base: 701 Yes No 77% 10% The preferred biometric authentication method for marketplace transactions is facial recognition (see Figure 19). Borrowers also tend to encourage their family members, friends and others to join marketplace lending networks (see Figure 15). Lending to groups can alleviate defaults (even for borrowers with good peer ratings) because peer pressure and community support would work to counter the incidence of default. While borrowing in groups is an important item in borrowers’ wish lists, security of transactions is the most important requirement. The Security of Transactions The security of transactions is a critical consider- ation in any online business. This is especially true in marketplace lending. The absence of effective security features is a major deterrent for both borrowers and lenders. An overwhelming 97% of respondents consider security features and data privacy important for marketplace lending sites (see Figure 16). Of those surveyed, 87% expressed a willingness to adopt biometric security features for market- place transactions (see Figure 17). Lender Requirements From lenders’ perspectives, returns of close to zero14 from traditional investment options such as bank deposits make marketplace lending platforms much more attractive. Lenders believe marketplace lending allows them to choose borrowers and have greater control over their investments, and comes with the ease and efficiency of online access (see Figure 20, next page).
  • 10. cognizant reports 10 Marketplace platforms also allow lenders to per- form their own analysis and choose their borrower. They can create and use their own models to make sure the default risk is minimized. Moreover, marketplace platforms provide different buckets of loans, based on their proprietary models. Choosing a Borrower Lenders are comfortable lending to someone they know, since they believe the chances of default will be small. In the absence of knowledge of the borrower, lenders prefer to lend to those rated15 highly by the platforms because the risk of default is less. They are also willing to lend to a group of individuals who join together to request a loan, believing that peer pressure on the syndi- cate members will result in repayment of the loan (see Figure 21). The preponderance of loan default is an open question since most loans issued on marketplace lending platforms have yet to run their full course. This could result in marketplace lenders reporting higher-than-actual returns. Wish List of Features Any innovation in business is marked by new features that set it apart from existing business practices. However, once consumers are accus- tomed to these attributes, they will demand more. Reasons to Choose Marketplace Lending Figure 20 Response Base: 349 18–24 25–34 35–44 45–54 55–70 Others Lower risk than capital markets Alternative investment option to diversify funds Help fellow borrowers who need the money High rate of returns for investments Quite easy and efficient with online access Better control over investments Option to choose the borrowers (whom to lend to) Do not like to work with big banks/institutions 2% 1%3% 5% 5% 1% 16% 2% 3% 9% 13% 2% 29% 2% 5% 7% 13% 3% 31% 1%5% 12% 11% 3% 32% 1%5% 11% 17% 3% 39% 3% 8% 13% 15% 3% 43% 3% 7% 13% 17% 3% 45% 1% 2% 3% 1% 10% 2% 1% Willingness to Lend to Individuals Figure 21 Response Base: 349 Not Sure Very Uncomfortable Not So Comfortable Comfortable Very Comfortable Lending to someone you don't know 9% 61% 26% 64% 3% 1% Lending to someone from the same community 8% 26% 42% 22% 77%2% Lending to someone with a good credit rating 19% 44% 30% 80%3% 4% Bidding on a competitive loan listing that has lenders bidding 16% 46% 32% 73%2% 4% Lending to someone endorsed by his/her friends & family members 17% 42% 35% 74%2% 4% Lending to a friend or family member 16% 54% 26% 87% 2% 3% Lending to someone rated highly by the lending site 19% 51% 22% 81%6%2% Lend more often if the lending platform is providing reasonably accurate prediction of borrower’s repayment ability 49% 32% 79%14%2% 3% Lending to a group as a whole 16% 24% 78%56%2% 2%
  • 11. cognizant reports 11 The key features lenders desire from market- place lending platforms provision for bad debts, a legal framework to deal with defaulters, partner- ships with retail banks and minimum guaranteed returns, for example (see Figure 22). Preferred Types of Loans Lenders prefer to fund loans for vehicles, edu- cation, small business and home improvements (see Figure 23). Most marketplace loans do not involve collateral. Although regulatory authorities require market- place platforms to meet a minimum prudential requirement, lenders can still lose most of their money. Marketplace platforms have now begun to issue small business loans. These loans are also unsecured but require personal guarantees by the business owner. In the future, marketplace platforms may begin providing secured loans backed by business assets. 7% 4% 2%Liquidity of investments 6% 1% 2%Recommendation engine for choosing the right loans 13% 8% 4%Online tools for portfolio analysis, risk calculation, etc. 15% 11% 5%Lender and borrower interaction 9% 14% 5%Deposit insurance like FDIC for bank accounts 9% 15% 5%Branch availability of marketplace lending site 11% 11% 6%Collateral-based lending 13% 13% 12%Minimum guaranteed returns 5% 7% 15%Partnering with retail banks 6% 5% 21%Legal framework for defaulters to comply 7% 11% 23%Provision fund for bad debts Features Sought by Lenders Figure 22 Response Base: 349 Feature Priorities: Third Second First Marketplace Loan Types Figure 23 Response Base: 349 Preferred loan types by marketplace lenders 36%127 28%99 28%98 27%95 18%63 17%58 13%47 13%47 10%35 9%33 7%24 5%18 2%8 Vehicle loan Education loan Small business loan Home improvement loan Medical expense loan Debt consolidation loan Payday loan Wedding loan Mortgage Unsecured debt Secured loan with collateral not covered above For domestic money transfer or International remittance Others
  • 12. cognizant reports 12 Opportunities exist for marketplace lending platforms to offer loans for education and medi- cal expenses. Both lenders and borrowers have shown an interest in these loan categories (see Figure 24). There are marketplace lending platforms that specialize in a wide range of niche loans, such Opportunities in Marketplace Lending Figure 24 Response Base: 701 Lenders’ Willingness Borrowers’ Willingness 36% 20% Vehicle Loan 28% 28% Education Loan 18% 28% Medical Expense Loan Purpose of Marketplace Borrowing Figure 25 Response Base: 352 Paying bills (credit card, utilities bill, etc.) Home improvement Repaying debt Medical expense Education Travel Vehicle purchase Wedding Mortgage Starting up a business Domestic money transfer or international remittance to family Others 38%132 30%107 30%104 28%99 28%99 25%87 20%71 10%36 9%33 8%28 6%21 1%3 as payday loans, purchase finance, education finance, real estate, merchant cash advance and loans to small and medium businesses. Examples of these platforms are Kreditech, Greensky, SoFi, Pave, Realty Mogul, C2FO and Kabbage.16 In April 2014, Lending Club acquired Springstone Finan- cial, a platform for making marketplace loans available to people undergoing elective surgery.17 CommonBond connects student borrowers with lenders. Most of these lenders are alumni who provide loans at rates lower than current market rates. Borrowers turn to marketplace lending sites mainly for paying bills (credit card, utilities, etc.), home improvement expenses and for repaying debt (see Figure 25). According to the World Bank,18 estimates indi- cate that the international money transfer (remittance) market will reach US$707 billion by 2016 — a large market opportunity by any standard. Money transfer could represent a significant business vehicle for marketplace lending companies. The Remittance Business: An Opportunity
  • 13. cognizant reports 13 Willingness to Make Domestic/Inter- national Money Transfer Based on Individual Credit Rating/Guarantee Figure 26 Response Base: 236 Not Willing Somewhat Willing Very Willing Personal guarantee 4% 31% 65% Credit history 251% 48% A majority of lenders (65%) are willing to make domestic/international money transfers based on personal guarantees. A significant (48%) percentage of respondents are even willing to make these transfers based on credit history (see Figure 26). The Way Forward Our study’s findings offer insights that can help marketplace lending platforms align their strategies with lender and borrower requirements and consolidate their positions. With this in mind, we recommend the following approaches to help them increase their market share: • Focus on vehicle and small business loans. For vehicle loans, the vehicles can be used as collateral. This provides a greater degree of comfort to lenders. Similarly, for small business loans, business assets can be used as collateral. Not surprisingly, there is a sig- nificant demand for small business loans following the global recession, since banks are no longer providing these loans in volumes that meet market demand. • Focus on loans for real estate and also student loans. Our survey also found that individuals interested in buying real estate are willing to approach marketplace lenders for loans in order to obtain better terms and conditions. Some students opt for marketplace loans; in many cases, they have few options. • Provide more options to lenders to analyze loans. Flexibility in deciding who to lend to is important. Marketplace platforms use proprietary tools for classifying borrowers (see sidebar, next page). They should also provide sufficient data about borrowers, as well as tools for performing an in-depth analysis of this data. Lenders should feel comfortable about the borrowers with whom they transact. Lenders should also be allowed to conduct a portfolio analysis of their invest- ments in marketplace platforms. • Consider both financial and social factors while categorizing loans. Social media indi- cators, such as recommendations by peers and past lenders, are significant predictors of creditworthiness. These should be considered before deciding on loan quality. Any borrower with a strong social network but a high likeli- hood of default should be encouraged to bor- row in a group. Peer pressure and a sense of belonging to a group can reduce the chances of default. • Provide quick approval of loans. Our survey confirmed that this is one of the most Expectation of Repayment of Money Transfer Loan by the Receiver Figure 27 Response Base: 236 Repayment of money transfer loan by the receiver Not sure No Yes 89% 6% 5% Willingness to Borrow and Pay from Marketplace Lending Sites While Shopping Figure 28 Response Base: 236 No Yes 92% 8%Paying for purchases while shopping Of those lenders surveyed, 89% believe that the amount of money transferred will be repaid by the receiver (see Figure 27). Real-time money transfer is another feature that borrowers desire; 92% of respondents indicated they are willing to borrow from a marketplace lender to shop (see Figure 28).
  • 14. cognizant reports 14 important features desired by borrowers. Application questions should be short and well written; moreover, marketplace lending platforms should follow a one-time approval process. • Security of transactions. Biometric security should be provided. Marketplace lending con- sumers are even willing to pay for such a fea- ture. This would also increase the adoption level. • Money transfer facility. There is a significant demand for both domestic and international money transfer. If this can happen in real time, borrowers will receive immense benefits. Lend- ers are willing to participate in money transfer Improving the Lending Platforms Most lending platforms use proprietary models to underwrite loans. These models are guarded closely because they are the biggest differentiators in this industry. Platforms use various techniques involving advanced analytics to ensure that the loan is underwritten based on accurate probabilities of default for different borrower segments. The classification of loan types into different loan grades determines the interest rates on each loan offer. Some institutional funds that invest in marketplace loans use artificial intelligence-based algorithmic techniques to find the best loans from lending marketplaces. Such machine algorithms pick up the most significant predictor variables from the pool of available data published digitally through these platforms. Each predictor variable is evaluated in complex combina- tions with other co-related variables. Those variables are chosen because they actually impact return on investment.19 Lending platforms could therefore use artificial intelligence in addition to the credit- scoring models to make themselves more attractive to lenders. Quick Take based on the credit history of the borrower and also on the basis of personal guarantee. • Leverage banks’ networks for a sustain- able future. Both lenders and borrowers have shown their inclination to lend/borrow more with a marketplace lending organization backed by a bank. Banks are considered more trustworthy due to security of investment and government support. Lenders/borrowers also want more branches and face-to-face inter- action with one another. This can be readily provided by banks. The high failure rate of the marketplace platforms can be significantly reduced if banks get involved directly with them. Appendix Study Methodology This survey was conducted online among a nationally representative sample of approxi- mately 11,000 U.S. consumers, roughly 701 of whom are marketplace lenders or borrowers, during February and March of 2014. Data was collected on marketplace lending and borrowing perceptions, preferred features, attitude towards domestic/international money transfer, and major concerns regarding marketplace lending and borrowing. The analysis includes: • Important predictors of loan default. • Profiles of borrowers based on their propen- sity to default. • Features desired by both borrowers and lenders. (See Figures 29 to 31 for respondents’ profile details on the next page).
  • 15. cognizant reports 15 Respondents’ Demographic Profile Gender Annual Income Figure 29 AgeGeographic Region East 33% South 12% Midwest 27% West 28% 57% 43% Less than 30K 8% Mean Median 30–49K 11% 65.2K 75K 50–74K 18% 75–99K 41% 100–149K 19% Above 150K 3% 18–24 5% Mean Median 25–34 16% 38.3 35 35–44 32% 45–54 38% 55–70 8% Above 70 1% Ethnicity and Employment Status Figure 30 Ethnicity Employment Status 2% Student4%Retired 1% Home- maker22% Self- employed Employed 68% 2% Un-employed 60% 18% 12% 7% 1% White Asian/Pacific Islander African American Latin American Others Respondents with Bank Accounts, Credit Cards and Loans Figure 31 Planning for Loan No Yes Bank account 1043% 97% Credit card 10% 90% 5% 33% 62%Active loans
  • 16. cognizant reports 16 Footnotes 1 http://www.economist.com/news/finance-and-economics/21597932-offering-both-borrowers-and- lenders-better-deal-websites-put-two 2 http://www.foundationcapital.com/downloads/FoundationCap_MarketplaceLendingWhitepaper.pdf 3 http://www.p2plendingnews.com/2011/04/u-s-peer-to-peer-lender-loanio-to-shut-down-operations/ 4 Peer to peer lending in the United States: Surviving after Dodd-Frank. http://www.law.unc.edu/components/handlers/document.ashx?category=24&subcategory= 52&cid=923 5 http://www.p2pmoney.co.uk/companies.htm 6 http://online.wsj.com/news/articles/SB10001424052702303595404579318440300379408 7 http://www.lendacademy.com/two-big-banks-enter-the-international-p2p-lending-scene/ 8 http://www.nytimes.com/2014/05/04/business/loans-that-avoid-banks-maybe-not.html?_r=0 9 http://www.ft.com/intl/cms/s/0/9a8e427e-2a07-11e3-9bc6-00144feab7de.html 10 We used a logistic regression model to identify significant predictors of default. 11 The classification of borrowers is based on a statistical technique called cluster analysis. We arrived at four segments based on hierarchical clustering. Then, using K-means clustering, we profiled the segments. 12 http://www.wiseclerk.com/group-news/countries/germany-p2p-lending-with-cars-as-collateral/ 13 If a person in the group defaults, there is peer pressure to repay. If he defaults, the member is excluded from the group and finds it difficult to borrow in the future. 14 https://www.bankofamerica.com/deposits/bank-account-interest-rates.go 15 P2P platforms categorize borrowers based on their credit rating and proprietary credit models into high risk to low risk. Returns for lenders are high for more risky categories and vice versa. 16 http://www.foundationcapital.com/downloads/FoundationCap_MarketplaceLendingWhitepaper.pdf 17 http://www.nytimes.com/2014/05/04/business/loans-that-avoid-banks-maybe-not.html?_r=0 18 http://www.worldbank.org/en/news/press-release/2013/10/02/developing-countries-remittances- 2013-world-bank 19 http://www.lendacademy.com/new-fund-uses-artificial-intelligence/ Credits Authors Soumya Sen, Client Partner, Banking and Financial Services, Cognizant Sanjay Fuloria, Ph.D, Senior Researcher, Cognizant Research Center Analyst Krishnakanth Sutrave, Researcher, Cognizant Research Center Design Harleen Bhatia, Design Team Lead Suresh Sambandhan, Designer
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