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2022 | OriginalPaper | Chapter

3. Challenges for P2P Lending Business Models and Banks

Author : Pelma Rajapakse

Published in: Law and Practice of Crowdfunding and Peer-to-Peer Lending in Australia, China and Japan

Publisher: Springer Nature Singapore

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Abstract

Chapter 3 investigates the principal challenges in such business models. Challenges to be considered, but not limited to, would be regulatory, technology, innovation and marketing. This chapter also explores the challenges marketplace lending may pose to traditional intermediation.

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Industry face various risks inter alia default risk, operational risk, and policy risk. See for example Jianjun Li, Sara Hsu, Zhang Chen and Yang Chen, ‘Risks of P2P lending platforms in China: Modelling failure using a cox hazard model’ (2016) 49(3) The Chinese Economy 161.

However, some P2P lending platforms have access to a limited credit history of their customers for example, My089.net has access to the payment history, most of the platforms are limited to the data entered by the borrower. See Jianjun Li, Sara Hsu, Zhang Chen and Yang Chen, ‘Risks of P2P lending platforms in China: Modelling failure using a cox hazard model’ (2016) 49(3) The Chinese Economy 161.

P2P platforms do not evaluate the borrowers’ trustworthiness, assess the financial risks associated with loans, or help lenders make investment decisions. Thus, lenders must bear higher risks than they used to when using traditional financial institutions. Jennifer J Xu, Lu Yong and Chau Michael ‘P2P lending fraud detection: A big data approach’ In Pacific-Asia Workshop on Intelligence and Security Informatics (Springer, 2015) 71-81.

Naoko Nemoto, DJ Storey and Bihong Huang, ‘Optimal Regulation of P2P Lending for Small and Medium-Sized Enterprises’ (ADBI Working Paper number 912, ADBI, January 2019).

United States Government Accountability Office, ‘Person-to-person lending: New regulatory challenges could emerge as the industry grows’ (Report to Congressional Committees, 2011).

See the discussion in Cambridge Centre for Alternative Finance, Harnessing potential: The Asia-Pacific Alternative Finance Benchmarking Report (2015) (online, 10 February 2009) <https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternativefinance/downloads/harnessing-potential.pdf.>

Jonathan J Rusch, ‘Memorandum to the Compliance Counsel, United States Department of Justice’ (2015-2016) 6 Harvard Business Law Review Online 69.

See Naoko Nemoto, DJ Storey and Bihong Huang, ‘Optimal Regulation of P2P Lending for Small and Medium-Sized Enterprises’ (ADBI Working Paper number 912, ADBI, January 2019).

FCA facilitates new regulation by allowing selected firms to test new models on the P2P market. This dialogue-based method enhances the FCA’s development of new, arguably market friendly, regulation. Opinions sought from the industry relate to the successes and constraints of the existing framework and the risks facing the industry with the view of addressing such issues via new regulation. See Financial Conduct Authority, Interim feedback to the call for input to the post-implementation review of the FCA’s crowdfunding rules (Feedback Statement, 2016).

Naoko Nemoto, DJ Storey and Bihong Huang, ‘Optimal Regulation of P2P Lending for Small and Medium-Sized Enterprises’ (ADBI Working Paper number 912, ADBI, January 2019).

J Yin, ‘P2P lending industry in China’ International (2017) Journal of Industrial and Business Management 1(4). In 2016 it has been identified that more than one-third of the PRC’s P2P lending platforms as “problematic” out of which a large proportion of cases referred to fraudulent behaviour. See S.Leng ‘One third of China’s 3000 peer-to-peer lending platforms ‘problematic: new report’ (2016) South China Morning Post. (on lone, 20 February 2021) <http://www.scmp.com/news/hong-kong/economy/article/2022317/one-thirdchinas-3000-peer-peer-lending-platforms-problematic#!>; W Yiqing, ‘Surge in P2P scams leads to stronger supervision’ (2016) China Daily. (online, 20 February 2021) <http://europe.chinadaily.com.cn/business/2016-10/09/content_27000442.htm.>

The Economist, In fintech China shows the way, The Economist. February 2017 (on line, 20 February 2921) <http://www.economist.com/news/finance-and-economics/21717393-advancedtechnology-backward-banks-and-soaring-wealth-make-china-leader>

Naoko Nemoto, David Storey and Bihong Huang, ‘Optimal Regulation of P2P Lending for Small and Medium-Sized Enterprises’ (ADBI working paper 912, 2019).

G Wildau, ‘China P2P regulations target hucksters and risktakers’ (August 24, 2017) Financial Times.

Information disclosed to investors includes how the borrower plans on utilizing funds, availability of collateral for the loan, and an anonymized description and comments about the borrower. See Naoko Nemoto, David Storey and Bihong Huang, ‘Optimal Regulation of P2P Lending for Small and Medium-Sized Enterprises’ (ADBI working paper 912, 2019).

It is worth considering the concept of regulatory sandbox in the UK context. See also Financial Services Agency, Access FAS No 198 (online, 20 February 2021) <https://www.fsa.go.jp/en/newsletter/accessfsa2020/198.pdf>; Anderson Mōri & Tomotsune, Fintech regulation in Japan (online, 20 February 2021) <https://www.lexology.com/library/detail.aspx?g=7ef5c941-493b-4b1c-b871-ad3e3351fcd7>; Fitch Solutions, ‘Japan Fintech: Short-Term Structural Issues Could Hinder Long-Term Potential’ (20 January 2020) (online, February 2021) <https://www.fitchsolutions.com/non-bank-financial-institutions/japan-fintech-short-term-structural-issues-could-hinder-long-term-potential-20-01-2020>.

See the discussion made in Benjamin Käfer, B. (2018) 69(1) Peer-to-Peer lending–a (financial stability) risk perspective. Review of Economics, 1.

In 2014, four paper companies in Guangzhou, China, committed fraudulent loans, causing a P2P website, My089, a total of ¥ 100,000,000 bad debt risk. See Chad Albrecht, Victor Morales. Jack Kristian Baldwin and Steven Deron Scott. ‘Ezubao: a Chinese Ponzi scheme with a twist (2017) Journal of Financial Crime 24(2); Funding Societies, P2P lending on a global scale (on line as at 20 February 2021) <https://www.tradegecko.com/blog/small-business-growth/p2p-lending-on-a-global-scale>.

However, an important criterion for judging whether a funding process is a “Ponzi scheme” is to determine whether the value of underlying assets is higher than the amount of money invested. See for example Peihua Fu, Anding Zhub, He Nic Xin Zhaod and Xiulin Li, ‘Threshold behaviors of social dynamics and financial outcomes of Ponzi scheme diffusion in complex networks (2018) Physica A: Statistical Mechanics and its Applications 490(15).

Zhou Fang, Jiajun Zhang and Fang Zhiyuan, ‘Study on P2P E-Finance Platform System: A Case in China’ (Conference Paper, IEEE 11th International Conference on e-Business Engineering, 5-7 Nov. 2014).

Traditional financial services company are constrained by the fact that their systems are generally built on legacy technology and thus, it is difficult to adjust and evolve. Also, it may be expensive to replace and adjust.

For example, some P2P platforms are using cloud-based microservices, that enables the system to be scalable and open to continual development and deployment. In contrary, traditional lending markets have the obstacle of revisiting a legacy system architecture when they are attempting changes in line with market dynamics.

Micro finance or any such mechanism with smaller loan amounts has the issue of high cost. Yet, P2P lending has manged to keep its operational costs significantly lower compared to other similar financial methods doe to automation. See Arvind Ashta and Djamchid Assadi, ‘The use of Web 2.0 Technologies in online P2P lending’ (Conference Paper, First European Research Conference, Brussels, June 2-4, 2009).

See for example Kate Beioley, ‘Peer-to-peer lender collateral enters administration’(March, 2018) Financial Times (on line, at 20 February 2021) <https://www.ft.com/content/5568a87a-1d36-11e8-956a-43db76e69936 >; Bavoso, Vincenzo, ‘The promise and perils of alternative market-based finance: the case of P2P lending in the UK’ (2020) 21 Journal of Banking Regulation 395.

For example, there may include efforts to get platforms to ringfence client funds that have not been allocated, and perhaps right to a withdrawal period and higher capital requirements to support the platform during times of financial difficulty.

See Y Chen, ‘Domestic online P2P companies mutate into shadow banks – Ali should prevent the systemic risk of scale loans’ (24 June 2013) Oriental Morning Post.

Each and every transaction in the ledger is authorized by the digital signature. This authenticates the transaction and safeguards it from tampering.

A likely analogy is a Google spreadsheet shared among several computers in a network, in which, the transactional records are stored based on actual acquisitions. The difference is uses are not allowed to change those records.

Costs pertaining to monitoring and evaluating borrowers.

For example, in bitcoin 1 MB per block is needed in every 10 min.

See the discussion in Ana Reyna, Cristian Martín, Jaime Chen, Enrique Soler and Manuel Díaz, ‘On blockchain and its integration with IoT. Challenges and opportunities (2018) 88 Future Generation Computer Systems 173.

It is noteworthy that in the primary market, the retailer needs to set its retail price, and in the secondary market, the platform may make a fixed profit as a commission charged from consumers that is set before the transaction. See Weimin Ma. Chenrui Zhao. Hua Ke and Zhiyi Chen, ‘Retailer’s Return Policy in the Presence of P2P Secondary Market. (Jan-Feb 2020) 39 Electronic Commerce Research and Applications’, 100899.

Selling a loan could be done with a premium or a discount, depending on the supply and demand, but defaulted loans cannot be sold. A sale fee is charged by some platforms.

See Dylan Yaga, Peter Mell, Nik Roby and Karen Scarfone, ‘Blockchain Technology Overview’ National Institute of Standards and Technology Internal Report 8202 (online, 20 February 2021) <https://arxiv.org/ftp/arxiv/papers/1906/1906.11078.pdf>.

Olena Havrylchyk and Marianne Verdier, ‘The financial intermediation role of the P2P lending platforms’ Comparative Economic Studies 60(1) 115. We are engaging in a lengthy discussion on Blockchain technology elsewhere in this chapter.

See Lifei Jiang, Stanko Dimitrov and Benny Mantin, ‘P2P marketplaces and retailing in the presence of consumers’ valuation uncertainty (2017) 26(3) Production and Operations Management 509.

By tracking Lending Club’s secondary market, it is possible to derive the fair market value of each loan and act upon this knowledge for profit. In theory, after deriving the fair value of each loan on the marketplace, it should be possible to purchase notes priced below fair value and immediately trade them at fair value to gain a marginal return.

Stephen Harvey, ‘Lending Club’s Note Trading Platform Facade: An Examination of Peer-to-Peer (P2P) Lending Secondary Market Inefficiency (2018) Honors Theses 199. Also see Rongxin Zeng, ‘Legal Regulations in P2P Financing in the US and Europe’ (2013) 10(3) US-China L. Rev 229.

Most countries do employs CBRs, yet, a large potion of P2P lenders are informal and are not listed on CRBs since they have little access to formal financial systems.

Bavoso, Vincenzo, ‘The promise and perils of alternative market-based finance: the case of P2P lending in the UK’ (2020) 21Journal of Banking Regulation 365.

Jennifer Xu J, Yong Lu, and Michael Chau, ‘P2P lending fraud detection: A big data approach’ (Pacific-Asia Workshop on Intelligence and Security Informatics (Springer, 2015).

Jianjun Li, Sara Hsu, Zhang Chen and Yang Chen, ‘Risks of p2p lending platforms in china: Modeling failure using a cox hazard model’ (2016) 49 (3) The Chinese Economy 161. Also see Yuwei Yan, Zhihan Lv and Bin Hu, ‘Building investor trust in the P2P lending platform with a focus on Chinese P2P lending platforms’ Electronic Commerce Research 18(2) 203.

Jianjun Li, Sara Hsu, Zhang Chen and Yang Chen, ‘Risks of p2p lending platforms in china: Modeling failure using a cox hazard model’ (2016) 49 (3) The Chinese Economy 161.

Y Chen, ‘Domestic online P2P companies mutate into shadow banks – Ali should prevent the systemic risk of scale loans’ (24 June 2013) Oriental Morning Post.

Title: Challenges for P2P Lending Business Models and Banks
Author: Pelma Rajapakse
Publisher: Springer Nature Singapore
Book: Law and Practice of Crowdfunding and Peer-to-Peer Lending in Australia, China and Japan
Print ISBN: 978-981-19-3833-7

Electronic ISBN: 978-981-19-3834-4

Copyright Year: 2022
DOI: https://doi.org/10.1007/978-981-19-3834-4_3