Maturity Transformation in P2P lending
Industry conferences tend to be very similar year on year, similar presentations, same people, same stories but this week’s Lendit conference produced a real surprise. Lord Adair Turner, former chairman of the UK’s financial regulator, who less than 8 months ago derided the peer to peer lending industry with his comment
peer-to-peer lenders could be the source of losses that would “make the worst bankers look like absolute lending geniuses”
attended the conference to present a keynote speech. Every presentation across the two days was very well attended but Lord Adair’s was standing room only.
In true politician fashion, he shocked everyone by backtracking from his previous stance, stating that
online peer-to-peer lending platforms — which match individual lenders seeking high returns with people and small businesses who want to borrow — could perform credit underwriting as well as established banks. I don’t think the use of technology by peer-to-peer lenders or challenger banks will do anything fundamentally new … but they might be able to do credit underwriting as well as established banks and also aspire to offer better customer services,”
Urging lenders to
“keep it simple, keep it transparent”, he said the £2.7bn industry would continue to grow if lenders avoided “giving the illusion of liquidity” to consumers using the platforms to lend money at a profit.
However, both he and Christopher Woolard of the FCA stressed that
lenders should avoid the practice of “maturity transformation”,
where platforms lend money for longer than it was originally borrowed for.
Banking’s biggest risk is maturity transformation, the practice whereby they borrow money on short timeframes (savers deposits) then lend money out (loans and mortgages) on longer timeframes. If the short term savers all withdraw their money at the same time, the bank doesn’t have the available funds and there is a run on the bank. Classic example, think Northern Rock.
Peer to Peer platforms, in theory, should never suffer from this risk as the money coming in to fund a loan is equally matched with the loan term. Investors get their money back when the loan is repaid. The only way they can get their money back earlier is through a platforms secondary market, assuming they have one.
But not all P2P platforms operate the same business model, some do run what we can term vanilla peer to peer models. These will never suffer from maturity transformation as investors invest on a loan by loan basis, matching each investment with the term of the loan.
Other platforms offer, what on the surface looks like a time based deposit, whereby they offer the investor a 3.5% return for a 1 year or 5% for 3 years.
Once invested, the investor has no say in who their money is lent to, at what rate and most importantly for how long. So monies invested by the investor for one year, could end up being lent to a borrower as part of a 3 year loan.
How then does the investor get his principal investment plus interest back when the one year date comes around?
In my opinion, the only way that the 1 year investor is getting his money back, is either from either fresh investor money coming to the platform or another loan being redeemed at the same time. This is a classic case of maturity transformation which both Lord Turner and the FCA are rightly concerned.
Peer to Peer lending is not banking, so let’s try not get tarnished by the same old banking problems.