Peer-to-peer lending - a disruptive threat to banks?

By Gavin Smith
Anti-bribery & AML Banking & Finance Financial Services Technology & Outsourcing

In brief

One of the things we are very interested in at the moment is how peer-to-peer lending will develop in Australia, and how it could be a disruptive threat to banks. We're not the only people who are interested though. On 4 December, it was announced that a powerful consortium comprising James Packer, News Corporation and Kerry Stokes had struck a deal to take a 25 per cent stake in SocietyOne. SocietyOne was launched in 2012 as Australia's first peer-to-peer lending platform and also counts Westpac as one of its early stage investors. Partner Gavin Smith, Senior Associates Matt Vitins and Andrew Edington and Lawyer Michael Beaconsfield report on peer-to-peer lending, and how it is regulated in Australia.

The amounts loaned through peer-to-peer (or P2P) platforms in the United Kingdom and United States are now being counted in billions. In the US, the market is worth more than US$6 billion annually, and, in the UK, more than GBP1.5 billion. The upcoming Lending Club IPO in the US is poised to see the company valued at more than US$5 billion. These are not trivial sums of money. And there has been a corresponding increase in the press and public attention paid to P2P lending as a form of alternative finance, which, in turn, is generating more and more interest from consumers. We are looking at a classic network effect.

So the question we at Allens are asking ourselves is this: could P2P lending be the disruptive threat to the banking industry that iTunes was to the music industry or Uber has been to taxis?

P2P lending refers to the practice of individuals lending money to one another through an online platform. P2P loans typically involve a number of lenders contributing small amounts to a loan. In this way, lenders limit their exposure to a default by a particular borrower. The promise, for lenders, is that they will receive a higher interest rate (or yield) on the money that they put into the system than they would by leaving it in a bank account. The promise for borrowers is that P2P loans are generally less expensive than loans arranged through a bank or traditional financial intermediary. To put that into perspective, an unsecured personal loan from a bank in Australia might have an interest rate of around 14 per cent. A P2P loan for an individual with a good credit rating might be as much as 4 per cent cheaper than that. And, as an alternative source of finance, borrowers may also find P2P loans more readily available, flexible and sensitive to credit-scoring than approaching traditional lenders.

P2P lending is now developing quickly in Australia. Start-ups in this area have taken various approaches to fitting within Australia's regulatory regime. In the past couple of years, two P2P lending platforms have been established in Australia as licensed managed investment schemes. SocietyOne was the first platform in Australia to use the managed investment scheme structure. The other main player in the Australian market, RateSetter, launched about a month ago having already become well established in Europe. SocietyOne and RateSetter both focus on consumer loans. SocietyOne also operates a livestock loan platform. In these areas, the P2P lenders consider that they can easily undercut the large spread between the rates offered by traditional financial intermediaries to borrowers and lenders. We expect other P2P lenders focusing on business lending to launch in Australia in the not-too-distant future.

The P2P lending model broadly fits within Australia's existing managed investment scheme regulatory structure. In its submission to the Financial System Inquiry, SocietyOne wrote:

We don’t believe the current regulatory framework is a barrier to P2P models. On the contrary we believe that the current regulatory framework provides appropriate protection for consumers and guidance for P2P lenders.


That's a different position to some of the challenges faced by other innovative financial products. Crowd-sourced equity funding platforms, for example, pose substantial challenges to existing the legislative framework and assumptions and have prompted an ongoing process of substantive law reform.  That law reform process will need to be completed before crowd-sourced equity funding platforms will be able to flourish properly in the Australian market.  

SocietyOne and RateSetter both operate as managed investment schemes under the Corporations Act 2001 (Cth). SocietyOne operates through a wholesale unregistered scheme. RateSetter operates through a registered scheme. It has also issued a product disclosure statement that will allow retail investors to put money into the RateSetter lending platform. As an interest in a managed investment scheme constitutes a financial product, P2P lenders will generally be dealing in a financial product in a manner that requires an Australian Financial Services Licence (AFSL). P2P platforms can either hold the AFSL directly, or operate under the auspices of an AFSL held by another entity. This is how SocietyOne has established itself. Holding an AFSL licence does require certain capital and cash requirements to be met but, depending on how a new entrant structures itself, these are not overly onerous. If a new entrant outsources the custody role, they can be kept to a reasonably minimal level.

As P2P lenders offer credit, they require an Australian Credit Licence (ACL). P2P lenders also need to comply with know-your-customer (KYC) requirements under anti-money laundering and counter terrorism financing (AML/CTF) legislation and the credit provider and credit information requirements under Part IIIA of the Privacy Act 1988 (Cth). This latter compliance requirement is both a burden and a benefit; P2P lending platforms are hugely reliant on default risk assessment data and so access to enhanced credit reporting information is a big help to them. Interestingly though, default rates on peer-to-peer platforms in the US and UK have so far tended to be quite low.

Across the Tasman in New Zealand, the Financial Markets Authority (the equivalent to the Australian Securities and Investments Commission) began issuing specific P2P lending services licences in October 2014 (one of six new types of financial services licences available in New Zealand). By regulating P2P lenders under their own category of licence, the New Zealand authority is well placed to rapidly respond to changes in P2P lending practices.

So there are compliance requirements and some regulatory barriers to entry here in Australia. However, the existing regulatory regime currently provides a comfortable level of consumer protection without strangling an innovative new industry. A happy moment where technology and existing laws get along.

Will peer-to-peer lending platforms create a significant dent in the profits of the big four banks? We doubt it. Unsecured personal lending probably accounts for no more than around 5-7 per cent of the profits of each of the big four banks. But, in the long run, we do think that peer-to-peer lending platforms will provide an extremely interesting new layer of competition in the financial system, for both lenders and borrowers.