Social lending and Banks

Social Lending also known to as Peer-to-peer lending has been gaining market share in the last decades. Currently, loans issued through this platform represents a third of the total amount of unsecured loans in the United Kingdom in 2017, and the revenue collected via this platform is projected to increase at 20% annually over the next decade. So far, in the history of banking, there is no banking institution (both formal and informal), that has experienced such a success. This success is attributed to the structure of simple and straightforward structure used by social lenders when compared to high street banking. Social lending is designed as a two-sided framework, which incorporates both traditional and current banking practices both on the investor’s side and the debtor’s side. The borrower’s side majorly depends on a streamlined online application process that applies financially sustainable information technology to gather consistent information from isolated individual debtors on a large scale. As much as social lenders pre-screen loan applicants modestly, they allow and depend on investors on lenders to screen their clients directly, which gives the lenders access to continuous and tailored exposure to an asset class, which they could not have accessed (Lenz, 2016). The social lending model majorly differs from the conventional banking system, where depositors are primarily isolated from borrowers. Besides, investor composition on lending platforms has been developing significantly since the acceptance of social lending because of informationally sophisticated investors’ increasing participation. These varied lenders have internalised large scale borrower screening, which challenges the conventional duties of high street banks, which is information production and screening on behalf of investors (Cull, Davis, Lamoreaux, & Rosenthal, 2006). To get a clear picture of how social lending has primarily replaced the roles of high street banking, it is prudent, to first identify the roles of high street banking in brief, and then proceed to examine how social lending has taken up these roles.

The Roles of High street Banking

In the United Kingdom, High-end street banks were created to act as an intermediary between two parties. That is to intermediate between savers/investors (those who deposit money), and the borrowers who receive loans from these banks. Financial intermediary organisations comprise of other institutions like the insurance entities and pension plans, but they will not be used in this paper since they are not considered as depository institutions. Therefore, primarily high-end street banking was primarily formed to help individuals keep their money and lend loans to deserving clients (Jagtiani & Lemieux, 2017). However, with time banks have evolved to offer various services such as financial advisory, financial management institutions, and an agent that can be used to pay for various goods and services. Up to this extent, one can judge how social lenders are mainly replacing the roles of high street banking, as seen in the subsequent sections.

How social lenders are replacing the roles of High street banking

Social lenders mostly depend on their algorithm for credit underwriting, as compared to high street banks that rely on a piece of single information to make decisions concerning the creditworthiness of a borrower. Hildebrand, Puri, & Rocholl (2016) stated that some of the information used by social lenders to determine the creditworthiness of the clients includes both traditional and non-traditional information. Some social lenders have resorted to establishing their online lending systems that depend on large data sets in their patented algorithms that have been established to analyse the creditworthiness of borrowers. Using this new method to evaluate creditworthiness, some clients have enhanced their accessibility to get loans (De Roure, Pelizzon, & Tasca, 2016). For instance, clients with short credit history might fail to satisfy the lending requirements stipulated by high street banks, but the same group of clients can have access to a loan from an alternative online financier that uses different data bases.

However, there have been various fears that the confidentiality of consumers could be compromised in cases where social lenders share the information like insurance entitlements, utility bills, communications in bank financial records among others without the consent of the potential lender. A study conducted by Duarte, Siegel, & Young (2012) in Germany in regards to information sharing among social lenders, revealed that 93% of clients using social lending institutions trust the institution with their information, and believe that these institutions only use this data for the sake of business. As per the findings of this study, then it means that most lenders using Social lending institutions cannot be deterred from using these institutions because of the fear of losing their information to unauthorised sources. Therefore, the fear of compromising client’s information does not in any way limit the growth of social lending. Aranoff (2016) also analysed the impacts of the freshly developed small business credit scores on loaning activities. The researcher concluded that the SMEs credit scoring depressed the information expenses and information differences between lenders and borrowers, which leads to an increase in the accessibility to loans for small business. Besides, one can project that the algorithm used by Social lenders will expand lending activities of some clients who are deemed undeserving by high street banks. Secondly, the fact Social lenders have a favourable credit rating system, they are likely to attract more clients due, which in turn compromises the role of high street banks (Lin, Prabhala, & Viswanathan, 2009).

Lower Loan Interests

The most straightforward strategy that a financial institution can use to attract borrowers is through giving credit at a lower interest as compared to other players in the market. Moritz & Block (2016) conducted a study on lending rates in the United Kingdom and concluded that loan rates in high street banking institutions vary by the purpose of the loan and that commercial loans are subjected to higher interests and ratings even after controlling the quality of applications received by a bank. These results were made in comparison with the loan interests offered by social lenders.

The same results were also recorded by Burtch, Ghose, & Wattal (2013) who conducted a study in France Social Lending institutions, which confirmed that bank lending rates were higher compared to the loan interests provided for by social lenders. The researchers also stated that after regulating risk elements of debtors, interest rates are slightly lower for Social lenders when compared to those made by the high street banking system. Milne & Parboteeah (2016) studied the rise and popularity of Social lending, evidence from the study stated that social lenders clients are among the debtors who get fast and appropriate services.

The competitive advantage of Using Social Lending

The rapid growth of Social lending has seen these institutions doubling their yearly income in the past decade. There are several reasons why this growth is expected to continue, and how social lenders are likely to replace high street banks. These factors include;

Social lenders have adopted various technologies that have allowed them to match the services offered by high street banks. The fact that through the internet, these lending organisations can enhance dissemination by allowing various partied to communicate directly with each other is an essential feature that among social lenders that would enable them to replace the conventional duties of high street banks. However, the projected growth in the near feature is due to various competitive advantages of social lending institutions of the existing ones like banks. Bruton, Khavul, Siegel, & Wright (2015) grouped these advantages into four classes, which are giving better rates of return as compared to the available banks, with relatively lower charges for debtors. Secondly, giving credit to the group of debtors who have been deemed not creditworthy by high street banks. Thirdly, an assumption that social lending is more responsible and has a better social value compared to high street banks. Lastly, technological developments have led to the enhancement of value and speed of services to both debtors and investors. Some of these advantages have discussed already, and therefore, the subsequent section will try not to dwell much on the already discussed content.

From Investors Perspectives

High street banks have always promised better returns to individuals who invest their money in these institutions. For a long time, banks have been the only depository institution that has been offering returns for money deposited in their respective accounts. However, this situation changed in the last decade when investors on social lending platforms over the last five years have been achieving relatively better returns than those who have invested in conventional bank accounts. This is partly due to the cost advantages of social lending organisations in contrast to high street banks (Segal, 2015). The streamlined trait of Social lenders actions guarantees that the organisational and overhead expenses needed for establishing such a platform is truncated. These bodies also have the capability of matching the borrowers and lenders since they do not hold any loans themselves, without any interest margin (Bertsch, Hull, & Zhang, 2017) as much as social lenders are prone to more risks since there is no deposit assurance and no guarantee of revenues. So far, such risks have been compensated for by higher rates of return.

Another reason for social lending success is the provision of greater access to credit, as discussed earlier. During the global economic recession, most high street banks in the United Kingdom were reluctant to give credit to borrowers. Most individuals and SMEs fail to satisfy the requirements banks place on granting loans (Agrawal, Catalini, & Goldfarb, 2011). However social lenders are alternative lenders who have persistently shown that they are prepared to take the risk of giving such credits and providing them at a lesser interest rate.

Direct linkages

Social lenders directly link lenders and borrowers, which give a socially advantageous form of finance, deprived of complaints that are sometimes pressed on banks that they tend to exploit the market and unorthodoxly pursue profits without enough consideration of their clients (Milne & Parboteeah, 2016). Social lending has somehow eroded this notion, by the fact that they are considered to be friendly and help consider the interests of their clients.

Technology

High street banks spend much money on technology, even so, most of it goes towards the maintenance of the existing system, instead of acquiring new ones. Social lenders also seek to replace the duties of banks by using innovations that can project and implement functioning schemes that can exploit the newest technological platforms; this, in turn, allows social lenders to offer quality services to their clients; this is through a simple loan application process, and a flexible framework for monitoring loan repayments and client commitments (Ravina, 2008). On the lender's side, this technology helps them to monitor their lending trends, and track their investment status. Besides, technology also social lenders to provide new procedures to the intermediation that were not offered by high street banks before. They also use the same technology to march lenders and borrowers

Conclusion

Any financial institution including banks cannot ignore the recent growth in social lending. However, high street banks have also adopted a perception of viewing social lenders as partners in the market, rather than viewing them as rivals. In some instances, banks have partnered with the institutions to finance these institutions, and to take an active role in the ever growing and profitable social lending trends. Besides, this partnership, social lenders have taken an active role in the financial market, and emerging as among the most preferred lending institution and therefore replacing most duties that were undertaken by high street banks in the previous decades.

References

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