Given that for a few short years, very prominent executives at the biggest banks in the world were publicly worry that the emerging marketplace and online lenders were amassing in the wings and waiting to eat their lunch, one might expect that recent pyrotechnics in the sector were not a totally unwelcome sight.
No one wants to see investors lose money, and it takes a particularly cold individual to cheer for another person facing jail time, but given the cavalcade of headlines proclaiming the end of days for the big banks, perhaps a little schadenfreude would be unsurprising.
After all, there is nothing quite like hearing a persistent narrative of one's own doom spelled out — over and over and over — or being told that your overlarge, overstuffed and overly extended dinosaur of a business model is about to be subdivided into all its component parts and offered more efficiently by technologists.
We can imagine it would be a little bit satisfying to then watch the world wonder if it is actually a bit harder to subdivide and offer bank-like services without actually being a bank than all those editorials and powerpoint decks made it sound like.
But when we talked to some big bank executives who spend their days and nights tweaking and perfecting their institution's loan offerings for consumers and small businesses, we found a somewhat different story. While both of the two banking execs we spoke to admitted to cracking an amused smile or two during the first few rounds of Lending Club headlines, by the end of the week they were actually a bit more worried than amused.
Lending Club clearly had a lot of issues, and a lot of problems that went a lot too far before anyone really had a clear picture of just how serious the problems were, one exec told us, but apart from that very specific story, the whole meltdown that has followed has left a set of questions that aren’t really well answered when it comes to underwriting consumers and small businesses.
Lending Club did a lot of things wrong specific to it, and online-based lending has a lot of issues with questions hanging around them that need answers. But even from inside the credit and risk shops at big banks, online lenders also clearly got a few things right and pointed out features that need to be part of modern underwriting, no matter what entities end up being the primary drivers of it in the future.
Marketplace Lenders: The Good
What marketplace lenders got right is that presence and paper are a problem when it comes to underwriting. Presence meaning the forced requirement of being in a branch location, and paper being the large and often redundant physical (smudgable, notarized) packet that consumers and small businesses need to be carrying in two for the “traditional underwriting process.”
Worse than being annoying at best, or an actually onerous requirement at worst, the presence and paper also suffer from being out of step with every other part of a customer’s life, including their banking experience. Customers who want to pay bills, manage their accounts or invest money are all ready to go with a website or mobile app, but customers that wanted to arrange the loan were seeing the clock wind back 25 years.
“The marketplace lenders were 100 percent right on that point. It is unreasonable to say when you want a loan, the year is 1996 all of a sudden, the Internet barely exists and it is a three-month process. The idea that because we couldn’t match an instant approval process meant the only other option was something cumbersome incredibly slow, that was wrong. I don’t think there were a lot of people in banking actually advocating that though. Most serious people understood the increased speed requirement, but there weren’t no people thinking that way.”
Both sources however did note that banks did get themselves to get saddled as the standard bearers for slow services and it was unhelpful. The need of a digital makeover for efficiency was never really something up for debate.
Marketplace Lenders: The Disturbing Unknown
But increased speed isn’t the only issue. The push for greater inclusiveness is.
Again, both sources agreed that post Great Recession, online lenders found a grey space in the regulatory process to offer credit to those who were essentially locked out of the mainstream markets. Big banks — faced with increased regulatory scrutiny and the reality that high-risk lending had nearly knocked a staggering number of them right out of existence — were under a lot of pressure to get out of consumer and SMB credit markets, and so they largely did. At the point that consumer and SMB lending became high cost, high risk with low profit margins, it became much less tempting for banks to compete, because there is not really a good way to make money.
And, notably, marketplace lenders aren’t making money on the loans so much as they make money creating the loans, and creating enough of them that they can be packaged into bonds and sold to investors. But the only way it works is if they can create a lot of loans, for those coveted networks effects that former Lending Club CEO Renaud Laplanche often referred to, and to do that according the banking executives, online lenders all have to make a similar claim.
They are better at assessing risk such that they can make more “good bet” loans of the type that can pay off for investors.
“And the problem is, it isn’t clear if they can do that yet. Does looking at 100,000 data point that scans your entire social media profile and everything you bought on Amazon and factors it in, does that turn up a result that is both a lot more inclusive than what U.S. Bank or Bank of America would have underwritten for anyway - and if it is - do all those extra people that we said were too risky actually turn out to be good bets?”
Only time could ever have told that, because the only way to find out if someone will actually pay on a loan is to see if they actually pay on a loan over time. Or if they default.
But the early data is not entirely inspiring. Most of the major online lenders we cover at PYMNTS have reported higher-than-expected default rates in some of their loans' bonds, and at least once this year so far.
Which means that Lending Club in specific, and online lending in general, are likely facing something of a hard reset button in the coming months as efforts are made to rebuild investor confidence. This brings both good news and bad news.
The good news is they’ve already made their case for faster, and, whatever happens next, it seems the pressure is on to streamline underwriting.
The bad news is more - as in more inclusive - is still up in the air, as it remains to be seen if there is a profitable way to get more good loans in, as opposed to just more.