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What banks can learn from Peer to Peer Lending success

Colin Strong
LDN - 03 Jun 2015
Colin Strong

Depending on your point of view, alternative financing is currently feeding a massive bubble or entering a flamboyant golden age. Either way, recent technological developments mean an increasing number of consumers are getting themselves acquainted with new, and dare I say it, exciting ways of buying, investing or borrowing. Here are some of the lessons banks could learn from one of the most recent and interesting disruptions to personal banking. Hint: It’s not all about the money.

Of all types of alternative financing used in the UK, peer to peer lending is the most popular. The category covers consumer lending, where individuals lend money to other individuals and business lending, where individuals lend money to businesses. The industry lent more than £459 million in the first quarter of 2015, an increase in lending on the previous quarter by a third. As peer to peer platforms such as SoFi diversify into student loans and mortgages, “peers” are not just offering an alternative to consumers; they are establishing a new financial system that is exponentially eating away at traditional lenders’ shares. And indeed the value proposition to give each party a better deal by decentralising lending is an appealing one. But peer to peer lending also comes with a bundle of nonfinancial incentives that could inspire established players.

1. Address the need for honesty, fairness and transparency

7 years after the financial crisis, the banking sector is still struggling to translate promises of transparency into more positive relationships with consumers. According to a 2014 survey, 1 in 4 UK consumers do not trust banks with their money, with a third of Britons having little or no idea about how banks invest their savings. Additionally, over half of UK consumers would consider trading with their own money. It would be fair to acknowledge that consumers don’t have trust issues, banks do.

  • Market clear, simple offers: In an effort to diversify their portfolio and differentiate their offers from the competition, banks have continuously developed new financial products and services. These efforts have often benefited marketing strategies but as a whole there is a sentiment that banking products and operations remain obscure to the uninitiated. Consumers are often faced with an overwhelming amount of offers of various level of clarity. In contrast, peers do not have ‘products’ but a simple proposition: you pick your level of risk and return, and you choose the company you want to invest in by scrolling down a repertory. That’s it, you’re done. At first glance this approach is of compelling limpidity.
  • Find yourself on the “right” side of the fence: By their positioning and offers, peers reinforce the idea that banks take more than their fair share. They propose a system where all customers have access to the same information and products, independent to how much money they have in their bank account. Peers champions, like Taavet Hinrikus from Transferwise find themselves on the consumer side of the fence. They publicly call for more transparency in finance, with fewer hidden fees and propaganda. This is the type of declaration that resonates with consumers.

2. Delight users with great experience and low barriers to entry

The large majority of consumers have embraced mobile banking for its convenience, but is yet more to do to improve customer experience. Successful internet services excel at user experience and limiting the barriers to entry, a domain in which peer to peer services tend to have a competitive advantage.

  • Make it Instantaneous: It takes about 5 minutes to set up a lender account online with one of the major peer to peer platforms. There is no waiting in line, booking appointments, discussing your financial goals, checking your solvency. Peer to peer clients also benefit from smart algorithms developed to vet and approve potential loan candidates. With fully automated assessment, same day funding is now made possible. A speed that clients of banks and building societies can only dream of.
  • Make it scalable: It’s easy to engage with peer to peer services because the platform does not discriminate on the size of your wallet and the approach is scalable. You can start lending right away with a small amount of money (£100 or £500 depending on the platform). This is ideal to feel included, and get your feet wet with investing at your own pace. Similarly, banks customers could benefit from an approach that is less intimidating.
  • Make it empowering: The peer to peer approach, devoid of complexity, empowers you as an actor and decision maker: you can be as involved as you want, from bidding for loans, to choosing expected returns or length of lend. Or you can put your trust in an algorithm and automate everything. When considering that nearly a quarter of Britons believe they could earn more from an investment if they had complete control over their money, rather than leaving it up to a bank, we can see how this approach may pay off. This “your money, your rules” policy could also help banks better their reputation.

3. Leverage the appeal of subjective product value

The peer to peer lending offer seems to address both sides of a product “value”: the intrinsic one (better rates) and the moral or subjective one that offers’ intangible benefits to consumers. As we look to the future, the latter could play a bigger part in the traditional offering of banks and building societies. Millennials particularly are likely to let moral principles and ethics guide their choices and behaviours.

  • Help people who want to make the world a better place: Peer to peer lending took off during the economic crisis when small businesses unable to lend from banks found solace in alternative financing. In the same way the socially conscious consumer uses their purchasing power to try and positively influence the world around them (co-op, fair trade, local consumption, etc.); peer to peer lending makes it possible to directly help individuals and businesses for mutually beneficial outcomes. Banks should try to emulate this win-win proposition.
  • Help people who want to get involved: The economy is made of and by people. Far from removing investors from the reality of the market, peers enable consumers to play a role in the economy. Investors can pick “someone” not just something; put a profile and sometimes a picture on the business or individual being backed. It goes further than a cooperative or a local bank for local people as it lifts the curtain on what happens behind the scene. The lender is now an active agent in the economy, getting close to the action. This level of involvement does not exist with banks where the traditional disconnect between parties – essentially individuals - prevails.
  • Help people feel the reward of their collaboration: From the dawn of society, our survival has depended on our highly collaborative behaviour, which is encouraged and incentivised by success. Of course a lender has a vested interest in seeing the company or individual they support succeed, but what of the borrower? Could the social nature of the loan have a positive impact on default rates due to peer accountability? Because the peer to peer transaction remains mostly anonymous, it would be excessive to talk about a personal bond between lender and borrower, but it is important to let lenders find satisfaction and rewards in a service that transcends purely commercial transactions. Maybe it is not enough to invest in local or ethical funds if you can’t see what good you’ve done.

Competition and innovation are positive forces that drive the market forward. The ability of banks to understand and emulate peer to peer success will help the industry adapt and develop better products for their customers. Of all players, UK banks are possibly best placed for this leap forward as they both have the resources to make the change and operate in one of if not the most dynamic fintech scenes in the world. These are exciting times for banking.