The Role of Peer-to-Peer Lending in Financial Inclusion

> Posted by Tyler Aveni, Research, PlaNet Finance China
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Peer-to-peer (P2P) lending is on the rise – as evident by the hundreds of articles on the subject that have sprung up just this year. However, P2P, generally defined as individuals bringing together small sums of money to lend to other individuals, is hardly a new concept. Moreover, this process of lending amongst communities of small businesses and friends has been moving online for a decade now. And while money is now most commonly transferred between strangers, interconnectivity online has allowed the process to feel almost as intimate as lending among friends and family.

The two earliest entrants into the P2P industry have gained steady followings since their beginnings in 2005: Zopa, a large commercial P2P platform in the U.K. boasts high returns and low interest rates for participants; the U.S. non-profit Kiva facilitates philanthropic P2P lending, wherein microentrepreneur clients of “field partners” or local financial institutions in developing countries are paired with those willing to lend at a zero percent return (i.e. indirect P2P). Through nearly a decade of innovations and new players emerging, P2P has slowly become a disruptive force. Total origination remains moderate with some $2.4 billion originated through P2P in the U.S. last year, but growth has recently skyrocketed.The U.S. market is estimated to swell to$32 billion by 2016. By 2025, the global figure could be as much as one trillion.*

Why such fast growth?

The appeal of online lending is two-fold. First, humanizing the lending process draws on a public sense of community. Many people prefer supporting others in a transparent system of lending as opposed to relying on traditional investing and/or saving options offered by banks. Some borrowers say that knowing other individuals are on the hook, rather than a bank, has incentivized them to go the extra mile in making repayments. In this way, P2P is almost strikingly traditional in that it integrates elements of “group pressure”– a successful innovation in microfinance organizations throughout the world – into the lending process.

Second, P2P lending is often a cheaper form of lending. Online transactions mean little need for brick-and-mortar establishments. P2P lending in the West has developed advanced credit evaluation analytics, lowering default risk and, by extension, reducing costs further. The result is better returns and lower interest rates for most investors and borrowers. Consequently, existing borrowers and small and medium-sized enterprises have come in droves to refinance their debts via P2P platforms.

Rishabh Khosla of Accion’s Venture lab sees other innovations taking shape. One of these is “affinity based lending,” or lending amongst those of a particular group. At StreetShares, a U.S. P2P platform that targets veteran groups and veteran businesses, borrower and investor acquisition has taken on a new grassroots quality. Khosla notes that “The key to vastly lowering the cost and making this market happen is low-cost borrower acquisition, low-cost lender acquisition, and then a really good engine in the middle to assess and underwrite these borrowers.”

P2P lending is pushing financing toward greater credit accessibility in myriad ways. When defined broadly, financial inclusion has already felt the positive effects of P2P lending’s development. Credit for small businesses means economic growth, entrepreneur support, and potentially more employment. Consumers trapped into exploitative interest payments on credit card debt can find some reprieve with P2P refinancing. High-achieving students and P2P lenders are proving to be an especially attractive combination. Many borrowers voice their satisfaction with the entire process.

“Last-mile” borrowers are being affected as well, albeit at a slower pace. A reflection of the unique challenges in reaching poorer regions, a different sort of P2P business model has taken root in the developing world. Partnerships, such as Kiva’s, between microfinance institutions (borrower acquisition) and P2P portals (lender acquisition) have given a new swath of rural borrowers access to credit. Over-indebtedness caused by high interest rates and poor individual credit evaluation remains a concern. However, supporting the better-performing, lower-risk microfinance companies means formal loans are being made available, an attractive option to those who might otherwise resort to loan sharks.

In developing and developed markets alike, potential for high returns has attracted institutional investors who now see the industry as better-developed and less risky compared to its earlier years. As a result, institutional big money is pouring into the industry (both in the form of equity investments into platforms and total loan origination by them), adding to the rapid growth of P2P lending. China, home to the largest P2P market, serves as a good example: total loan origination via Chinese P2P companies has grown more than 200 percent in 2014.** This marks a global trend. With so many large investment firms getting involved, the industry looks distinctively more commercial.

But perhaps social and commercial interests stand to benefit from one another. A P2P industry with more visibility, even if primarily profit-driven, could benefit a whole range of P2P lending companies, from the philanthropic to the bank-like. After all, both types of platforms aim to improve on and fill gaps in current lending practices. The fact remains, however, that growing interest is moving the industry closer to institutional players. P2P companies and their business models may very well be absorbed by banks as part of a new age of efficient banking. What this would mean for P2P lending is unclear, but many are understandably wary of trusting big business to champion fair lending practices.

Regardless, authorities are clamoring to work out regulations for the nascent industry as P2P companies scale up. During this stage of rapid change in P2P lending, it will remain essential to keep track of where the industry is going and how best to try to shape it. Accordingly, Planet Finance will address some of the pressing topics in our upcoming research on P2P lending practices worldwide. The research comes as part of our Microfinance Robustness Program which promotes the sustainability of the microfinance sector and is supported by Credit Suisse, a partner of both Planet Finance and the Center for Financial Inclusion.

By exploring impacts of P2P lending in different communities and evaluating the potential it holds for extending financial inclusion, we hope to illuminate a socially minded narrative, one that discusses innovative bank to P2P company partnerships, and address concerns of P2P lending fueling over-indebtedness.There is currently a need to better define the P2P lending space, to better understand the complexities and risks of various business models, and to provide a more involved discussion of how the industry is progressing. Both the unfairly served and “underbanked” alike will ultimately benefit.

* Estimates from Research and Markets distributed report “Peer-to-Peer Lending: Global Facts and Figures 2014”

**Estimates from, a China P2P market monitoring website

Have you read?

China’s Microfinance Landscape: Nonprofits, Microcredit Companies, Rural Financers, and Alibaba

Reality Check: Three Ways We Hype Up Financial Inclusion Breakthroughs

Fueling the Economic Engine: Global Experiments in Small Enterprise Lending