While the rate of increase consumer borrowing showed signs of reducing in the second half of 2019, the trend is still upwards, leading to worrying levels of borrowing. While debt levels are outside the scope of this article, it's clear that lenders continue to show an increasing appetite. Notionally, MPLs may reduce the impact of predatory, high-interest payday lenders, but will they be willing to accept the high risk proposals that four-figure interest makes possible for the usurers?
Government-imposed restrictions on the activities of payday lenders have mitigated the financial damage that they can wreak, but arguably, their most serious flaw remains unchanged: it's too easy to borrow money. These companies specifically target people with poor or non-existent financial history. What, if any, identity verification and other background checks are being carried out? According to the Financial Conduct Authority, borrowers have repaid £2 billion in payday loans for an average payday lending of £1.3 billion in 2018. It may be that sizeable amounts are being traded with minimal policing.
The tightening of control on payday lenders has given rise to a new type of player in the marketplace. In peer-to-peer lending, often referred to as P2P, a broker connects borrower and lender in return for a fee. Background checks are usually handled by the intermediary. In this model, rates are relatively low and the identity of the borrower is often opaque to the lender.
|Comparison of Bank and P2P Lending|
|Traditional Banks||P2P Lending|
|High overheads (offices, staff, T&E etc)||Low overheads (usually online)|
|Low ROI (typically 1-3%||Higher ROI (typically 12-13%|
|Banks may use deposits (black box)||Investors direct their capital|
|Offer multiple products and services||Focus on peer or business lending|
|High cash liquidity||Limited by lender funds|
|Systemic risk due to proprietary trading and leveraged/packaged/synthetic instruments||One-pound-in/one-pound-out simplicity|
|Underwritten by government||Not underwritten by government|
While P2P lending has self-evident shortcomings, particularly in protection for the lender, its popularity has created explosive growth, expected to continue at over 40% until beyond 2022. With such large sums in play in an under-regulated marketplace, it's only a matter of time before the bad guys move in - and they may be here already. We've already seen punishing penalties imposed on established financial institutions - institutions which can survive and have survived their financial impact. It's unlikely that private and small lenders will prove so robust.
Without industry-wide controls and universal background checks, P2P lending could be a ticking time-bomb. Traditional lenders enjoy protections and procedures that currently aren't readily available to P2P lenders. Legislation will almost certainly be introduced to reduce this exposure, but can we afford to wait? The industry already stands at over GBP 16 million per year, and much of that lending has gone to individuals and companies about whom precious little is known.
Any loan application is likely to be checked for adverse history. But how can we be sure that the right applicant is being investigated? It's all too easy to clean up one's credit score, and even the creation of a false identity isn't an unobtainable goal. The penalties suffered by traditional financial organisations demonstrate that the credit checks that have served since last century are no longer adequate. Legislation is likely to be too late. P2P lenders need to protect themselves now or face a lending melt-down in the near future.
Credit history is just one aspect of a prospective borrower's profile. While next-gen due diligence systems like biz.Clarency will use it as a useful factor, it's nowhere close to providing sufficient information for a sound credit decision to be made. The 2020 approach positively identifies the applicant and performs automated background checks far beyond that which the applicant offers in the application form. The biz.Clarency document validation function can detect forged passports or duplicate identities in seconds.
As well as expontially decreasing the risk associated with a decision to lend, biz.Clarency also provides protection from prosecution should a bad transaction actually slip through. A detailed audit trail, rendered immutable by blockchain technology, demonstrates that every reasonable effort has been made to ensure compliance. Lenders thus enjoy two layers of protection.
It's not just borrowers who are potential wrongdoers. An under-regulated loans market is an attractive proposition for a money launderer looking to clean funds through low-interest loans. The compliance risk here is borne by the intermediary who introduces the lender to the borrower. The biz.Clarency KYC process takes in all of the actors in a transaction, in this case subjecting the lender to scrutiny to ensure that all funds have originated legally and ethically.
Any thorough KYC system has to encompass every player involved in the transaction. This could extend beyond borrower, lender and broker to include vendors or service providers. The more inclusive the verification, the safer the transaction will be for all concerned.
There's good news for those who make the step towards next-gen KYC-based compliance. Because the process is predominantly automatic, background checks are fast and cost very little. The resulting risk analysis can be quickly matched to a lender's profile to provide ideal matching, speeding the match-making process and increasing competitiveness. Borrowers can be offered faster decisions, and lenders' time isn't wasted with out-of-parameter propositions.
Blockchain technology is a major facilitator in the process. As well as providing the security and immutability for which the platform was developed, blockchain also brings us the power of the hash key. This unique identifier can be used to provide read-only access to authorised parties to real-time data concerning a loan. So the lender, and potentially even the borrower, can be automatically updated on their transaction's status, or near-real-time management information can be shared. By considered deployment, compliance can be converted into powerful competitive advantage.
Lending companies can achieve complete digitisation and automate their business with granular access to every financial information at every level of their business operation and smooth workflow.
Origination and Data Trails
Digitisation of data with Blockchain and instant ID verification systems can improve business efficiency. The decentralised ledger means that customer information is easily managed and stored within a shared access network. This reduces cost, speeds customer acquisition and simplifies document management. Borrowers and lenders can be quickly matched on the basis of financial credit history, ex-post delinquency rate, creditworthiness, financial success rate.
Instant availability of all information means that lenders and brokers can access every borrower’s loan request based on overall risk profile, increasing loan approval rates with real-time estimates for funds disbursal. Reliance on third-party intermediaries can be eliminated, again reducing cost and improving the overall customer, business and regulator relationships.
Every contract contained within biz.Clarency's blockchain-enabled ledger is, by definition, verified and authentic. This important reassurance is further enhanced by the system's continual diligence. Throughout the life of a business's or individual's engagement, the system continues to monitor behaviours and transactions. Any significant change can generate an alert. This means that previously checked companies and individuals can be serviced rapidly and with full confidence.
We began this article with a warning note, and the severity of that warning shouldn't be ignored. P2P lending is a booming sector, with opportunities for lenders, cheaper loans for borrowers, and a fertile furrow for intermediaries to plough. But, at least until legislation catches up with consumer demand, the risks to all concerned are potentially catastrophic.
But, for those with the vision and flexibility to lead the field in compliance, there's huge opportunity. As well as minimising risk, the early adopters will seize competitive advantage and prosper.