It is for a good reason that the industry changed its label from peer-to-peer lending to marketplace lending: Peer-to-peer lending is dead. Institutional investors have taken over the entire investor side of marketplace lending. The initial idea of connecting borrowers and lenders directly has been abandoned.

Excerpted from Jonathan McMillan (who visited the LendIt conference):

“It is for a good reason that the industry changed its label from peer-to-peer lending to marketplace lending: Peer-to-peer lending is dead. Institutional investors have taken over the entire investor side of marketplace lending. The initial idea of connecting borrowers and lenders directly has been abandoned. Now, hedge-funds, asset managers and banks are using marketplace lending as a supplier of loans in their chase for yield.

And with this development, marketplace lending becomes more and more integrated into banking. Companies such as Lending Club and Prosper have redefined themselves into loan originators and underwriters for traditional banks. One marketplace lending CEO I talked to explained that his company is a „raw material“ producer for the institutional investors. The times when the industry wanted to disintermediate the financial system are long gone.

Marketplace lending also connects with shadow banking. Asset managers have started to securitize marketplace loans into asset-backed securities, and hedge-funds use large amounts of borrowed money to leverage their investments. Some investors are already talking about the need to create credit default swaps for marketplace loans. Overall, the parallels between these developments in marketplace lending and the shadow banking that led to the financial crisis of 2007-08 become undeniable.

WHERE WILL IT GO?

Unfortunately, our predictions were right. Marketplace lending transforms into banking at a high speed. At the moment, the loans marketplace lending originates might still add value to a segment that has been ignored by the banking industry in the aftermath of the financial crisis. But abundant Federal Reserve liquidity and government guaranteed funding will eventually push monitoring standards down.

What shocked me the most were discussions around the growth of securitization. The industry recreates the same chain of financial commitments that led to a shadow banking panic in 2007-08. The resulting financial crisis has become a distant memory from the past. The big question really is how much marketplace lending can grow until the next financial crisis hits: will they succeed to become systemically relevant or will their investors lose out in the next credit crunch?

The LendIt conference affirmed my belief that we have to end banking with a systemic solvency rule to restore a functioning financial system. Otherwise, banking finds its way into every financial innovation, and transforms it into a device to circumvent regulations and increase risk taking. Marketplace lending is just one example in a long line of innovations.