Table of content
2. Literature Review
3. Evolution of P2P lending and its influence over the past ten years
4. Standing of P2P platforms in the Financial Services industry
4.1. Future Outlook
6. Reference List
Due to the exponential rate at which technology has developed in recent years, plentiful new businesses have established. The digital revolution is challenging many well situated, regulated and often conservative industries, such as the financial service industry. Several financial technology start-up companies, also known as Finance Technology Companies (FinTechs), thereby constitute as competitors to traditional retail banks by accessing technological innovations. While the FinTech “eToro” is challenging the investment divisions, start-ups like “Transferwise” are putting pressure on the prices for payment and transfer services (Hale, 2014; Kaminska, 2016; Milne, 2014). The largest market volumes of so-called alternative finance models in the United Kingdom (UK) have peer-to-peer (P2P) lending businesses, such as ZOPA (KPMG, 2015). P2P, or social lending allows individuals to borrow and lend money to each other directly, without intermediate financial institution, such as retail banks (Bachmann et al. 2011; Jones, 2014). Subsequently, the global trend of disintermediation also arose in the banking industry (Authers, 2014).
After reviewing relevant literature the market power of P2P lending as well as its impact on the financial services industry over the last ten years will be assessed. Furthermore, this essay will illustrate the current situation by evaluating the extent to which P2P FinTechs replace personal finance functions of retail banks in the UK. Finally, major aspects will be summarised and future aspects will be discussed.
2. Literature Review
The predominant view about the impact of P2P lending platforms on financial services in the UK is broadly consistent. Even though the topic has great popularity among newspapers and the consultancy industry, the past, as well the actual influence of P2P lending platforms on the financial position of the financial services industry is commonly assessed as modest. Underlying reasons for the assessment are the comparable small volume of borrowing and the small number of customers compared to the traditional retail banking industry (Barnes, 2015; Kupp and Anderson, 2007; Wallace, 2015), mainly because P2P platforms are not established among ordinary people (Mackenzie, 2015; Morgan Stanley, 2015).
Even though the actual financial impact on financial services is assessed as moderate, the literature is referring to the high growth rate that P2P platforms experienced in the past and the huge potential and influence that P2P platforms may have in the future (Bakker, 2015; Morgan Stanley, 2015; Nesta, 2016; PwC, 2015a). Estimations about P2P platforms’ volume of loans in the UK vary between £12.3bn (Wallace, 2015) and £24.1bn (Morgan Stanley, 2015) for the year 2020. Although, this is a small proportion compared to the outstanding loans of traditional banks, which amounts to £262bn (Wallace, 2015), it is commonly agreed that this may impact the profit of retail banks. Reading (2015) accentuates that if P2P lenders capture the retail mortgage market, UK banks will experience a threatening decrease in profit, as this is one of the most profitable market for the banks at the moment. Besides, Siedenbiedel (2015) emphasises that a single FinTech will not substantially threaten a bank, however, many FinTechs, such as Zopa, have specialised in one of the traditional banks’ functions. According to Deloitte (2015), Mackenzie (2015) and Siedenbiedel (2015), the threat for financial services provider is not that one single entrant or model will dominate their market, but the sum of FinTechs, which are capturing the market by increasing the efficiency of single sections of financial services providers and thereby alienate their customers.
While Barners (2015) argues that retail banks do not acknowledge P2P services in the marketplace in a sufficient way and thereby underestimate the potential risk, the predominant view is that financial services institution are aware of the increasing potential of FinTechs. An increasing number of partnerships as well as investments in P2P platforms reflect the acknowledgement and the impact that FinTechs have on the strategies of retail banks (Dunkley, 2015; Moules, 2014; Reading, 2015; Zopa, 2015).
3. Evolution of P2P lending and its influence over the past ten years
In the following, this essay will discuss social, political as well as macroeconomic influences on the market position of P2P platforms and banks during the past ten years.
Analysing the financial service sector over the past years indicates that technology is a not a new phenomenon. However, technological developments in the past, such as the electronic stock trading, Internet Banking or online stock trading, were enhancements to banking services, while new FinTechs might replace banking services completely (Desai, 2015; Zimmermann, 2016).
Constantly decreasing costs for technology resource development allows smaller firms to enter the market and challenge established, conventional financial services providers (Barners, 2015; KPMG, 2015; Moenninghoff and Wieandt, 2013). Deloitte (2015) assessed that it may cost less than £10mn to set up a small bank due to technological development. While traditional banks can handle only 7% of their products digitally from end to end, FinTechs commonly handle the vast majority of their products digitally and automated, which is not only cost-efficient, but also time- saving (Bain & Company, 2015; De Munck, 2014; KPMG, 2015). FinTechs save costs as they employ less staff and do not have a branch networks. These competitive advantages enable FinTechs to offer low interest rates for borrowers, higher interest for lenders, a simplified application process and much quicker lending decisions (Morgan Stanley, 2015; PwC, 2015a,).
Besides the technology development, macroeconomic and regulatory changes have boosted P2P businesses and influenced the development of retail banking negatively in recent years (De Muck, 2014). While regulations for retail banks have been tightened after the financial crisis in 2008, P2P lending platforms have not been affected (Mackenzie, 2015). Especially regulations for risker customers have been strengthened, as they experienced heavy losses during the financial crisis. Although theses borrowers were an essential component of the banks’ revenue before the crisis, today these loans are less interesting for banks due to increased regulations (Figure 1) (Bank of England, 2016; Lapavitsas and Costas, 2008). Furthermore, the interest rate has been increased for consumers and small businesses (Morgan Stanley, 2015; Morrison, 2014). Thus, banks are less attractive and the trend of consumers and small businesses using P2P lending platforms is fostered. Consequently, P2P platforms have the opportunity to capture the market and develop from niche offering to major players (PwC, 2015a). Morgan Stanley (2015) and KPMG (2015) argue that the lack of regulations is still the most influential competitive advantage of P2P services. Although banks developed similar technologies, regulatory issues and compliances hold them back (Mackenzie, 2015).
Figure 1: Lending to UK businesses
illustration not visible in this excerpt
(Source: Bank of England, 2016, p. 4)
In addition, traditional financial services providers suffered from a lack of trust of customers after several banks required a bailout by taxpayers during the financial crisis (De Munch; Barnes, 2015). KPMG (2015) found that even if a bank offers similar terms, 80% of the interviewed people would approach alternative finance platforms. While retail banks experienced a decreasing trust of their customers, P2P platforms benefit from the trend of a sharing economy, referring to consumers trusting relationships tied to social sentiments (PwC, 2015b).
The use of new technologies, highly automatized processes, as well as complex algorithms, minimises the FinTechs’ operating costs, and thereby often put pressure on the conditions that retail banks offer their clients (World Economic Forum, 2015). Besides, the financial crisis led to tighter regulations and missing customer’s trust. Thereby, banks are loosing their perceived security advantage (Deloitte, 2015) and lost several customers. Although all above-discussed factors indicate an increasing impact of P2P platforms on the traditional financial services industry, the actual impact is assessed as moderate. Even though P2P services experienced growth rates of up to 288% per year, their market share of loans, compared to the outstanding loans of traditional financial service provider was considerable small (Figure 2) (Bank of England, 2016; Nesta, 2016; Wallace, 2015). Accordingly, in the past banks had no pressing reason to be concerned with loosing considerable profits and customers to P2P platforms. Assessing non-financial aspects depicts that P2P platforms increased the pressure on altering strategy, increasing efficiency and implementing new technologies. In 2014 Santander was the first bank acknowledging P2P platforms as a competitor by partnering with one of them (Moules, 2014). This recent alliance illustrates that even the strategic pressure for traditional retail service providers were moderate until 2013 (Gallarotti, 2015; Morrison, 2014). However, more recent alliances, as well as heavy investments of banks in P2P platforms illustrate that especially during the year 2015, banks increasingly acknowledge P2P platforms as potential competitors and adapt their strategies.