P2P Industry Introduction: 2 out of 7
Do you want to be the boss of your own financial situation and make money by being an investor? The goal of this series of articles is to introduce you to P2P lending & crowdinvesting and to help you decide if this asset class makes sense for your investment portfolio!
Why include P2P lending to your investment portfolio was the first post of the series.
P2P Lending Market Overview
The P2P lending industry is relatively young. The first ever P2P platform was founded in 2005, however, the industry saw a rapid rise after the 2008 financial crisis, as most of the market participants have lost trust in the traditional banking system. Due to the young age of the industry, there is no centralized statistics source to estimate the true size of the industry. However, there are plenty of independent market research firms, that offer some insights.
The Transparency Market research firm estimated that the market size of P2P lending industry was $26Bn in 2015 and predicts that the compound annual growth rate (CAGR) will be 48.2% in 2016-2024 reaching the total market size $897Bn by the end of 2024.
American bank Morgan Stanley has predicted back in 2015 that the global industry will reach $490Bn by 2020, with US accounting for 45% of total global P2P lending market. A report by BI Intelligence estimated that in 2015 US P2P lending market has generated $6.6Bn in loans, making it the number one worldwide in loan volume, however, the UK is number one in per capita basis (72% higher than the US).
What the Future Holds?
Europe is the next big market for P2P investing. Cambridge Centre for Alternative Finance has estimated that in 2016 market reached €7.7Bn.
Regionally, the market for peer to peer lending is gaining traction and expanding from mature markets such as North America and Europe to various regions including Asia-Pacific, South America and Middle East & Africa. The Asia-Pacific peer to peer lending market, even with the Chinese experience is anticipated to grow at a rapid pace in the forthcoming years on account of the presence of massive student population in developing economies and an increasing number of start-ups and businesses looking for funding for their projects.
Lessons from China
Until 2018 the biggest market was China which accounted for more than 4000 companies. However, in June 2018 the market collapsed, with many P2P platforms going bankrupt and investors losing their money.
The Ezubao Scandal
Back in 2016, Ezubao one of the top 10 largest P2P lending platforms in China at the time, has been shut down and 21 executives have been arrested. Even though Ezubao only launched in July 2014, it quickly grew to attract hundreds of thousands of investors with promises of 9-15% returns.
The scale of the fraud was breathtaking. Around 900,000 individual investors have collectively been bilked out of US$7.6 billion, according to Chinese officials, in one of the largest Ponzi schemes ever conceived. It has been reported that an estimated 95% of all borrower listings on Ezubao were fraudulent. Meanwhile, the top executives used investor money to enrich themselves – spending on items and gifts including real estate, cars, and luxury goods.
From 2016 to 2018… More and more platforms…
But the industry rationalized this away as just one bad apple. The regulators announced new rules for the industry at the beginning of 2016 and there was a sense that the strong platforms would adapt and continue to perform well. And that is what happened for the next year or so. But by 2018 serious problems began to emerge. That year ended up being the year of reckoning for the industry.
The p2p lending industry had grown to around 4,000 platforms at its height which everyone agreed was not a sustainable number. The weak platforms were not going to make it but the trouble was as they failed they often took investor money with them. While there was definitely some fraud there were also cases of platforms that meant well but were simply unable to make online lending work.
Investors Guarantees and Losses
Many investors had put their life savings into a single P2P lending platform believing that their money was safe. Some platforms said they would guarantee investor principal and others implied they were backed by the government. What these investors did not understand was that once the platform went out of business these guarantees were worth nothing. But they truly believed the platforms should guarantee all these investments.
What Went Wrong?
Peer to peer lending was a failed experiment in China. It became so tainted by fraud and illegal activity that even the well-intentioned platforms have struggled.
When sourcing for responsibilities, the reason seems to go to a failure of the regulatory system. In 2013 the People’s Bank of China (PBOC) had identified many of the problems with P2P lending but did not do anything about it until it was too late. The reality is that it is really difficult to underwrite loans well. You need a lot of expertise, particularly when it comes to risk management, and only a small number of platforms fully realized this.
There was no signal of how trustworthy a platform was except for size and time on the market. So, there was a mad rush to grow very big, very quickly and there was little incentive to be a good actor. Many platforms that actually had effective risk management in place were overtaken (in size at least) by these young upstarts. It was a house of cards and in hindsight, it was no surprise that it all came crashing down.
What can we learn from it?
We need to actively ensure that the same mistakes don’t repeat themselves in Europe. It is our responsibility, as investors, to ensure we do proper due diligence and request greater transparency from the P2P industry. In a different approach, we need to push from decisive action from the regulatory bodies to establish a clear investor protection standard.
This is a clear example of the importance of careful analysis of the risk held by savers that need to spend additional time assessing the worth and seriousness of P2P platforms before investing.