As peer-to-peer lending grows in popularity and consumers increasingly have access to lenders outside of their local communities, what can community banks do to strengthen relationships and compete innovatively?
What is Peer-to-Peer (P2P) Lending?
Peer-to-peer lending, as it sounds, initially emerged to remove banks and other financial institutions from the borrowing and lending mix. Instead, fueled by technology and the digital environment, transactions could occur through individuals, investors and newly emerging businesses that have moved into this space. Lenders and borrowers are matched up through online platforms. Investopedia lists the six best peer-to-peer lending websites; they are:
- Funding Circle
- Prosper Marketplace – the first marketplace in the U.S.
- CircleBack Lending
- Lending Club
Before these options emerged in the marketplace, “banks owned the lending market,” says Mickey Goldwasser, VP of marketing with Payrailz, a digital payments company that offers advanced bill payment and money transfer solutions to banks and credit unions. “When you needed money, you went down to your local bank, filled out a loan application and they fulfilled that—they owned the market. There weren’t any other alternatives,” he says.
But something happened around 2008 that changed the lending landscape.
The Big Drivers of P2P Lending
In 2008, when the country went into a deep recession and many banks fell under scrutiny for their loan practices. “Banks and credit unions were really, really not in the business of wanting to lend,” says Goldwasser. “That created an opportunity where other people said, ‘well, people still need access to capital.’ That’s where there were groups willing to say, ‘we’ll take on the risks the banks don’t want to take on.’ In many ways that was the birth of peer-to-peer lending. The financial meltdown was really a time when banks ratcheted back, and they weren’t going to lend to just anybody. The introduced a lot of friction to the process, if you will.”
Today, not only are loans taking place without the need for a traditional bank, they’re also taking place without the need for a face-to-face interaction. The ability to use technology to expedite and simplify the lending process was another big driver shifting loans from banks to new sources of capital.
Why P2P Lending is Attractive to Consumers
“There are three major benefits of peer-to-peer lending that appeal to its growing market,” says Jennifer McDermott, a consumer advocate for finder.com, a personal finance comparison website. “The niche nature of the loans, a digitally-enabled application process and the speed in which these can be approved.”
Community banks, she says, “will have to either meet or counteract each of these benefits in order to win out with locals.” For instance, she says “there are countless alternative lenders that cater to very niche loan needs such as funding cannabis businesses or fertility treatments.” Community banks can have an advantage, says McDermott, because of their more in-depth understanding of the local community and its lending needs.
Not all business is necessarily equally at risk, of course.
(Prius) “In the community bank space, the consumer lending segment has been a rather small part of the community bank’s overall loan portfolio,” notes Prius. “Commercial real estate, home equity loans/lines and residential mortgages tend to be the predominant loan types,” he says. These loans require more time, effort and documentation. For mortgages, the process requires a lot of post-approval due diligence and simply may not be attractive to P2P lenders, at least not at this point.
Each community and each market will differ, of course. “Looking at areas such as community issues and the biggest economic opportunities for locals will help determine a niche community banks can carve out and own,” McDermott says.
How Community Banks Can Respond
It happened to Blockbuster. It happened to taxi cab companies. It happened to hotels. Now it’s happening to banks and other impacts are sure to follow. As shifts in traditional markets point to opportunities to fill a gap, make an improvement, or meet an unmet need and technology emerges to provide better service, better access—sometimes at a better cost—consumers will follow. These shifts represent risks to traditional providers. Blockbuster is just one example.
P2P lending has not yet reached the point where it threatens large, secured consumer and business loans. But the future potential exists, and the wake-up call has been made.
What can community banks to do address the potential impact on a core part of their business?
Thinking About Doing Things Differently
Organizations and individuals tend to take the path of least resistance until some outside force causes the to rethink the way they do things and ask new questions about how those things might be done better. Loans are a great example.
While community banks operate under a set of rules that P2P lenders don’t (at least not yet), there are still opportunities to rethink the processes behind making loans to identify ways to simplify and shorten the process in ways that appeal to consumers and, increasingly, to business owners.
The P2P lending concept worked. It started with consumers loans. But now we’re seeing it kind of morph into business loans,” says Goldwasser. “The investors and borrowers are meeting on that same website where someone is looking to lend money, and someone is looking to borrow money.”
Community banks need to pay attention, Goldwasser says. “When Uber first started, I’m sure the taxi cab companies were like ‘this is nothing.’ But it’s had a dramatic effect. In no way am I saying this is going to replace banks, but banks will have to be aware because it’s a competitive challenge.”
A good starting point for community banks, says Goldwasser, is taking a hard look at ways they might remove friction from the lending process. That may involve asking some questions that may be easy to ask, but tougher to answer, starting with: “Why do we do this, this way?” In some cases, it may be because of a regulation; in others, it may be simply based on some outmoded past practice that nobody has thought to challenge.
Now’s the time to challenge.
But, on a more positive note, community banks also have an opportunity to leverage some benefits that are unique to them.
If You Can’t Beat Them, Join Them
Joel Pruis is senior director with Cornerstone Advisors, specializing in commercial and small business lending. Opportunities may exist, says Pruis, for community banks “in the transition of these P2P lenders from direct lending sources to actual online application platforms that can be white labeled for use by the community banks.” In addition, he says: “Other opportunities lie in the ability of the community banks to actually directly invest or purchase loans form these P2P lenders.”
In some cases, community banks are finding opportunities to partner with P2P lenders, says Pruis. “In 2015 Lending Club partnered with BancAlliance which is a national consortium of 200 community banks to offer co-branded personal loans,” says Pruis. “Some of the larger banks have partnered up with OnDeck (Chase) and others. Typically, the partnership is based upon referring loan applications that might not meet the credit criteria of the bank. In some situations, the banks are actually using the P2P lender platform to process loan applications.”
Leveraging Community Relationships
“To combat the uptick in peer-to-peer lending, community banks need to return to their roots,” says Donovan Sipho, with Paraclete, Inc. “The reason why I and others have used community banks is because of the values that they stand for, as opposed to the corporate giant banks,” he says. Sipho, who is a marketing consultant, notes that peer-to-peer lending is standing up to the conventional banking system and suggests that community banks can do the same. He recommends that community banks:
- Highlight what they do for, and within, the communities they serve
- Involve the community in the bank, creating opportunity for the community to invest in the bank, as they invest in the community
- Give people a bank they can trust and believe in—a bank that is truly making a difference
Certainly, there will be—there is—some segment of the population comfortable with borrowing money in cyberspace from people and organizations they don’t even know. But there will also continue to be some segment of the population that prefers to borrow money from people and organizations that are part of the fabric of their communities—whose employees are their friends, relatives and neighbors; who they see participating in community events; providing support for local people and the local economy; and understanding, in a way that technology still can’t, what it means to be a community.