The Un-Level Playing Field for P2P Lending

This paper considers how regulation affects competition between traditional banks and new peer- to-peer (P2P or marketplace) lenders employing a platform-based business model to directly connect borrowers and investors. Such platform-based lending has the potential to dramatically reduce the need for banks to use their own equity capital to support credit risks and substantially increase the supply of credit to smaller and less credit worthy borrowers that are unable to directly access security markets. The impact of P2P lending has to date been quite modest, however, and may struggle to achieve the scale necessary to cover platform costs. For example, while P2P lenders have been active in the U.S. and the U.K. for more than a decade, they still hold less than 1% of the total stock of unsecured consumer lending and most platforms are losing money. P2P lending in other countries is still very much in its infancy. Only in the U.K. – not elsewhere – has P2P lending become an important source of loans for smaller companies. One reason for this modest market impact is that prudential regulation – in particular government sponsored and backed 100% insurance on all bank deposits under deposit insurance limits, even when held for investment rather than transaction purposes – gives banks a substantial advantage in the market for savings deposits, forcing P2P lenders to rely instead on unstable sources of wholesale funding and limiting their ability to compete with banks in the provision of consumer and small business loans.