Launching an Online Lending Business: A Blueprint for Taking Off

consumer loans

Consumer lending in the US reached nearly 1.5 trillion dollars in 2018, according to the Federal Reserve Board of Governors, and European banks reported a demand growth of 25% in the second quarter of 2018. Needless to say, it’s a good time for lending. While banks are still paying out the lion’s share of the […]

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consumer loans

Consumer lending in the US reached nearly 1.5 trillion dollars in 2018, according to the Federal Reserve Board of Governors, and European banks reported a demand growth of 25% in the second quarter of 2018. Needless to say, it’s a good time for lending.

While banks are still paying out the lion’s share of the loans, alternative lenders are gradually moving in to fill holes in the ever-increasing lending market.

Fintechs Exploit the Growing Market

The traditional banking sector is entrenched in their old way of doing business. Banks and customers alike expect a certain customer experience and style of operational management. While this may appeal to some customers and lending institutions, it comes at a significant cost. Each teller or call-agent interaction at a traditional bank costs an average of four dollars compared to merely ten cents for a mobile interaction.

While the profits of running a fintech are clear, the process of getting up and running is not without its challenges.

Practical Steps for Setting up a Lending Company

Lending markets vary from country to country depending on regulations, legislation, and consumer behavior. This simple roadmap outlines the general process to get started.

Point One: Becoming A Legitimate Enterprise

In order to start lending online, business owners need to create a legal entity. This is the vehicle that all lenders will use to navigate red tape. As this process varies greatly from business to business, it may take as little as 1% or as much as 20% of your initial startup budget.

The basic steps include:

One possible way of circumventing this is to purchase an already existing bona fide legal entity or lending franchise. For example, the largest franchise lender in the US is Liquid Capital. The short-term costs may run a bit higher, however, the long-term benefits of using an existing household name could potentially pay large dividends.

In addition to the unique requirements for lending entities, regular business costs will often crop up as well. Among others, these could include hiring and administrative overhead and office rental. On average, these costs could take anywhere from 10%-12% of your startup budget.

Point Two: Raising Funds

Raising capital to lend out is the primary operational challenge for any lending startup.

Usually the best way for a startup to begin lending is with their own capital, but when that is not possible (or favorable) funds can be raised in the marketplace. Recently, institutional lenders have become much more comfortable with providing capital to lending startups following the rise of the P2P model.

Any lending company funded by public investors will have to factor in the cost of hiring a Certified Public Accounting firm to perform an audit to certify all financial data including their business plan, valuation, and other financials.

Point Three: Using the Right Technology Platform

The core of any modern lending company is the technological platform it runs on. The platform is the brain of the business and takes time to nurture and grow. It is best to do this in parallel with the other points as it is the primary capital asset of the operation.

When it comes to platforms, there are two main options: building your own from scratch or purchasing an existing platform from a vendor. This crucial decision will have a long-term impact on the business and will greatly affect setup and operational costs. Each option comes with pros and cons:

  • Building a lending system from scratch is more time-consuming, and can take up to 12 months. It requires a substantial upfront investment as you will need both financial and technological expertise to pull it off. Additionally, time-sensitive shifts in the market could be a factor, so timing your release is of paramount importance. While this option could be risky, it gives lenders full control over the product they build.
  • Purchasing an existing lending platform is generally less expensive and faster. There are a wide range of solutions both out-of-the-box and fully-customizable. The options fall into two general categories: traditional core banking systems (eg. Oracle, Temenos, and Infosys) or fintech-focused solutions (eg. HES Lending Software).

There are number of software challenges that digital lender should consider when choosing a platform:

  • In order to optimize productivity, systems often require further customization.
  • Some systems only cover a single or hand-full of loan management aspects like underwriting, loan origination, or loan servicing, and do not support many back-office functions.
  • Systems often do not integrate with the majority of third-party services, so lenders might end up needing to mix and match software to run their business.
  • Some systems do not extend well into new markets or product segments.
  • Some systems require license upgrades to increase the loan volume or number of user accounts.

In Conclusion

With a good understanding of the industry, thorough planning, and about $200,000 to $1,000,000 of startup capital, a state-of-the-art lending business can be launched. Not only do these businesses financially benefit their owners and investors, but they come with the satisfaction of knowing that every loan issued has great potential for improving the lives of the borrowers and their communities.

Author:

Natalie Pavlovskaya is the Chief Marketing Officer at HES (HiEnd Systems), a fintech company behind comprehensive lending and credit scoring solutions. She is a Marketing Executive with international business experience in CIS, EMEA, and US, working for more than 7 years in digital marketing.

The post Launching an Online Lending Business: A Blueprint for Taking Off appeared first on Lending Times.

The Rise of UK Institutional Peer-to-Peer Lending

institutional lending

Institutional involvement in UK Peer-to-Peer lending remains low relative to the US, where institutions represent more than two thirds of the market. In 2015, institutions represented just 32% of consumer lending by total volume in the UK and just 25% and 26% of real estate and business lending respectively. So, why might this be? Well, […]

institutional lending

Institutional involvement in UK Peer-to-Peer lending remains low relative to the US, where institutions represent more than two thirds of the market. In 2015, institutions represented just 32% of consumer lending by total volume in the UK and just 25% and 26% of real estate and business lending respectively.

Source: 2015 Nesta Report

So, why might this be? Well, it’s fairly normal for institutional involvement to remain fairly low in the early stages of a new sector. On the most basic level, new sectors are simply not large enough for institutions to invest in, as they often require the ability to write large tickets, in the tens of millions, while also ensuring that they do not represent too large a proportion of a particular provider/platform. Also, until the sector gains the stamp of approval from the regulators and has a decent track record, those in charge of an institution’s wealth are simply unwilling to put their necks on the line for it. Instead, they’d rather invest in well-known, blue chip asset classes which their peers are all invested in too. There’s much less chance someone will get fired for those investments if they get into trouble. Furthermore, the P2P lending ecosystem is still in its early stages, which means that access to independent research and adequate due diligence tools are largely unavailable.

But, the sector is poised for change, and institutional involvement is growing. According to Nesta, in 2013 just 11% of P2P platforms reported some level of institutional funding. By 2015, this had increased to 45%. If we look at the big 3 platforms, which have the scale to accommodate institutions, this trend is certainly clear. Prior to 2014, these platforms had little to no institutional involvement, but institutional lending has increased significantly since then.

Institutional Lending (as a % of total volume)

Source: Orca Analysis and Assumptions. Data unavailable for Zopa in 2017

One of the key milestones for institutional involvement in P2P lending was the involvement of the British Business Bank. The British Business Bank is a UK Government-owned economic development bank established to increase the supply of credit to small and medium enterprises as well as providing business advice services. It has so far invested £135m through a number of P2P platforms including Funding Circle, through which it has invested £100m, Zopa, RateSetter and Market Invoice.

Additionally, there are a number of investment trusts available to investors which raise predominantly from institutions when they launch. Some of the larger investment trusts include P2P Global Investments (£730m), VPC Specialty Lending (£310m) and Ranger Direct Lending (£140m). Institutions have been attracted to these trusts thanks to their promise of high yields in this low yield environment and the belief that the teams involved have the skills to construct the best performing portfolios. Some of these investment trusts ran into a bit of trouble in 2016 when many began to trade at a large discount to NAV (>20%), having previously traded at a premium. Such price to NAV swings can be driven by numerous factors. Although it is likely that lacklustre performance of the underlying loans are a large contributing factor to declining sentiment, other short-term considerations are likely to also be at play. Some short-term explanations were provided by Cormac Leech, a principal at Victory Park Capital, who felt accounting quirks and Brexit / sterling weakening were causing the discount and that that these issues would be ironed out over time. Indeed, since the end of 2016, many of the discounts of the large investment trusts have narrowed by half.

Is this a good, or a bad, thing? There are a few different perspectives to take. Theoretically, institutional involvement is a great thing for borrowers, lenders and aggregators alike. Institutions mean more capital for lending, which in turn helps to grow the sector and stabilise the businesses of the platforms. Institutions help to also raise awareness with other investor groups, thus helping even more capital to flow into the sector. As platforms become larger and more profitable, we may also see cost savings passed on to investors.

This all sounds great, but there are a few snags to be aware of. Relying too heavily on institutional investors may cause investor concentration on the platforms, which leaves platforms vulnerable to being destabilised by just one investor withdrawing. Zopa and Funding Circle have both stated their commitment to retaining a diverse mix of investors, including retail, institutional and government funding. An issue that some of the larger platforms are already facing is that they are struggling to originate enough borrowers to keep up with the supply of lenders. This can cause issues for retail investors, as platforms may reject capital from retail investors (as Zopa has previously done) or platforms may be encouraged to take on riskier loans. The FCA recently stated that they were concerned about potential conflicts of interest that may be created by institutional involvement. The main concern here is that institutions may be able to cherry-pick deals to the detriment of non-institutional investors.

Another issue to be flagged is whether heavy institutional involvement undermines the social purpose surrounding P2P lending (i.e., finance ‘for the people, by the people’), which perhaps undermines the differentiating factor associated with the sector. While this is true to some extent, particularly in P2P equity crowdfunding and donations, P2P lending should ultimately be viewed as an investment opportunity which offers attractive yields with diversifying benefits in a well-constructed portfolio.

There may be some concerns but, on balance, institutional involvement should be seen as a positive sign for the P2P sector. So long as P2P participants remain well-versed on the risks involved and the FCA implements the necessary rules, institutions can help P2P lending to mature and grow in credibility.

Author:

Samantha McBride is a Director at Orca, which provides investors and financial advisors with the research required to perform in-depth due diligence on peer-to-peer investments. Samantha gained her Law degree in 2009 from the London School of Economics and has worked in financial services for the last eight years. Samantha began her career in mergers and acquisitions, working as an Investment Banking Analyst for both Nomura and Deutsche Bank, before moving into Investment Management. Prior to joining Orca, Samantha worked as a Senior Investment Associate at Partners Capital, a global outsourced investment office, and, most recently, a Portfolio Manager & CCO at Elm Partners, a quant-driven, low-cost investment manager.