{"id":17199,"date":"2016-11-18T00:57:05","date_gmt":"2016-11-18T05:57:05","guid":{"rendered":"https:\/\/digital.hbs.edu\/platform-rctom\/submission\/lending-club-can-technology-fundamentally-disrupt-how-we-invest-and-borrow\/"},"modified":"2016-11-18T00:57:05","modified_gmt":"2016-11-18T05:57:05","slug":"lending-club-can-technology-fundamentally-disrupt-how-we-invest-and-borrow","status":"publish","type":"hck-submission","link":"https:\/\/d3.harvard.edu\/platform-rctom\/submission\/lending-club-can-technology-fundamentally-disrupt-how-we-invest-and-borrow\/","title":{"rendered":"Lending Club: Can technology fundamentally disrupt how we invest and borrow?"},"content":{"rendered":"<p><span style=\"color: #000000\">Lending is an old, established, and successful industry. Historians traced evidence of grain loans as far back as the ancient world, and dated the birth of banks at around the 14<sup>th<\/sup> century [1]. Lending is also profitable: Finance is the third most profitable sector in the economy, with a 17.14% net margin [2].<\/span><\/p>\n<p><span style=\"color: #000000\">One potential explanation for the industry\u2019s longevity and success is the timeless and complex nature of the problem it solves. Many lenders want to invest excess funds for a profit, while many borrowers need money to finance their projects, such as buying houses, paying for education, etc. Although lending is mutually beneficial, parties have historically been unable to match without banks as intermediaries.<\/span><\/p>\n<p><span style=\"color: #000000\"><strong><u>How lending traditionally works<\/u><\/strong><\/span><\/p>\n<p><span style=\"color: #000000\">Traditional financial intermediaries collect funds from individual and institutions, against a promise to pay them back with interest. Intermediaries pool these funds, search for suitable borrowers with the right risk profiles, and lend them money at higher interest rates. Intermediaries profit by 1) lending at higher interest rates than what they pay to investors and 2) minimizing defaults through risk assessment and collections management.<\/span><\/p>\n<p><span style=\"color: #000000\">To implement this business model, <strong>lenders have traditionally needed large organizations and infrastructure<\/strong>. Physical branches and call centers service customers. Marketing teams increase sales. Trading desks invest temporary capital holdings. Risk teams ensure loans perform as expected. And the list goes on. For example, Wells Fargo, a commercial bank with a market capitalization of US$ 260bn [3] and US$ 1.9 trillion in outstanding assets, employs 268,000 people in 8,600 locations [4].<\/span><\/p>\n<p><span style=\"color: #000000\">But wait, this is 2016. Can digital marketplaces cut intermediaries out?<\/span><\/p>\n<p><span style=\"color: #000000\"><strong><u>Enter digital marketplaces: Lending Club<\/u><\/strong><\/span><\/p>\n<p><span style=\"color: #000000\">Lending Club is an internet marketplace that connects investors and borrowers directly, with limited intermediation. Founded in 2006, Lending Club is seen as the \u201cflagship company\u201d of the young peer-to-peer lending industry [5,6].<\/span><\/p>\n<p><span style=\"color: #000000\">Beyond spearheading digitization in the lending industry, Lending Club has also created a significant financial impact. To date, it has facilitated US$ 22.7bn in loans. Furthermore, Lending Club\u2019s model has been competitive by offering cheaper rates for borrowers and higher risk-adjusted returns for investors [6,9]. This enabled Lending Club\u2019s IPO in 2014, attaining a peak market capitalization of US $10bn [10].<\/span><\/p>\n<p><span style=\"color: #000000\"><strong><u>How is this different from traditional lending?<\/u><\/strong><\/span><\/p>\n<p><span style=\"color: #000000\"><strong>Lending Club\u2019s business model is fundamentally different.<\/strong> Instead of lending their own funds, <strong>Lending Club provides a marketplace<\/strong> where borrowers and investors make their own transactions. Borrowers publish loans, and investors handpick individual loans to invest in. In return, Lending Club charges a small service fee to both parties [11, 12]. As a result, <strong>credit risk is transferred from institutions to investors<\/strong>, who now bear the full potential gains and losses from their investment decisions.<\/span><\/p>\n<p><span style=\"color: #000000\">Also, <strong>Lending Club\u2019s operating model is much leaner than traditional institutions:<\/strong><\/span><\/p>\n<ul>\n<li><span style=\"color: #000000\"><strong>Fully automated loan approval.<\/strong> Borrowers fill an online form with personal and third party data, such as FICO scores. Lending Club then runs proprietary risk assessment and fraud detection algorithms to automatically approve the loan and set the appropriate interest rate given the loan\u2019s risk.<\/span><\/li>\n<li><span style=\"color: #000000\"><strong>No physical branches<\/strong>, as all operations can be done via the website.<\/span><\/li>\n<li><span style=\"color: #000000\"><strong>Less employees<\/strong>, with only 1,400 employees reported as of December 2015. [12]<\/span><\/li>\n<\/ul>\n<p><span style=\"color: #000000\"><strong><u>Recent trouble<\/u><\/strong><\/span><\/p>\n<p><span style=\"color: #000000\">Although Lending Club\u2019s model seem to make sense, trouble has hit the young company. Its stock price has steadily declined since the IPO, and currently trades 74% below its peak in 2014.<\/span><\/p>\n<p><span style=\"color: #000000\">Cited reasons include slight increases in default rates, which scared some investors away and pushed interest rates up, which in turn scared some borrowers away. With a fee-based model, Lending Club requires steady inflows of investors and borrowers to keep revenues up.<\/span><\/p>\n<p><span style=\"color: #000000\">Other cited reasons are on legal, compliance, and regulation. Some investors that lost money are suing through class actions. Scandals have arisen from claims that its founder used the platform for personal gain. Regulators are still scrambling to refine the right legal framework for these marketplaces. In summary, there is a lot of uncertainty ahead. [13]<\/span><\/p>\n<p><span style=\"color: #000000\"><strong><u>Looking ahead<\/u><\/strong><\/span><\/p>\n<p><span style=\"color: #000000\">In my opinion, Lending Club needs to strengthen its economics and reputation. For economics, Lending Club should continue perfecting its algorithms, to reduce defaults. It should also cross-sell highly-scalable financial services, such as insurance and automatic debt consolidation advice.<\/span><\/p>\n<p><span style=\"color: #000000\">I would also encourage Lending Club to fully disclose sources and uses of capital, to shatter any doub of shady deals. I would also increase social networks presence with educative videos on the risks of investing in loans, and how they can be managed but not eliminated.<\/span><\/p>\n<p><span style=\"color: #000000\">Regardless, the peer-to-peer lending industry is an exciting space likely to grow fast in the US and abroad. Its powerful value proposition and efficient operations are threatening to disrupt finance. However, will it have sufficient thrust to break into one of the most established and powerful industries in history? Only time will tell.<\/span><\/p>\n<p><span style=\"color: #000000\">(800 words)<\/span><\/p>\n<p><span style=\"color: #000000\"><em><u>References:<\/u><\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[1] Banking through the ages by Hoggson, Noble Foster, b. 1865, https:\/\/archive.org\/details\/bankingthroughag00hogg<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[2] \u201cThe most profitable industries in 2016\u201d, www.forbes.com, http:\/\/www.forbes.com\/sites\/liyanchen\/2015\/12\/21\/the-most-profitable-industries-in-2016\/#73cae7317a8b<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[3] Yahoo Finance, consulted on November 16, 2016<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[4] Wells Fargo Factsheet, 2<sup>nd<\/sup> Quarter 2016 https:\/\/www08.wellsfargomedia.com\/assets\/pdf\/about\/corporate\/wells-fargo-today.pdf<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[5] \u201cThe Stunning Fall of LendingClub\u2019s Founder\u201d, Bloomberg, https:\/\/www.bloomberg.com\/news\/articles\/2016-05-09\/lendingclub-founder-goes-from-wall-street-darling-to-unemployed<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[6] \u201cBanking without banks\u201d, The Economist, http:\/\/www.economist.com\/news\/finance-and-economics\/21597932-offering-both-borrowers-and-lenders-better-deal-websites-put-two<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[7] Latest Company Stats, Lending Club, consulted on November 17, 2016, https:\/\/www.lendingclub.com\/public\/about-us.action<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[8] United States Population Statistics, Census Bureau, consulted on November 17, 2016, https:\/\/www.census.gov\/popclock\/<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[9] \u201cLending Club Can Be a Better Bank Than the Banks\u201d, Bloomberg, https:\/\/www.bloomberg.com\/view\/articles\/2014-08-27\/lending-club-can-be-a-better-bank-than-the-banks<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[10] http:\/\/www.bloomberg.com\/news\/articles\/2015-06-29\/lendingclub-falls-below-ipo-price-after-49-plunge-in-six-months<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[11] \u201cFrequently Asked Questions for Investors\u201d, Lending Club, consulted on November 17, 2016, https:\/\/www.lendingclub.com\/public\/investing-faq.action<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[12] Annual Report 2015, Lending Club, http:\/\/ir.lendingclub.com\/file.aspx?iid=4213397&amp;fid=1001209585<\/em><\/span><\/p>\n<p><span style=\"color: #000000\"><em>[13] \u201cLending Club: Membership Revoked\u201d, The Economist, http:\/\/www.economist.com\/news\/finance-and-economics\/21698698-sacking-ceo-leading-peer-peer-lender-jolts<\/em><\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Banking has been around for 700+ years, and is the third most profitable sector in the economy. Financial intermediaries usually rely heavily on physical assesses and people. Is there a leaner way to do this? Lending Club says yes. The market&#039;s view is mixed. Read ahead to explore this topic.<\/p>\n","protected":false},"author":2452,"featured_media":17200,"comment_status":"open","ping_status":"closed","template":"","categories":[385,2205,1080,264,259,386,2459,387,262],"class_list":["post-17199","hck-submission","type-hck-submission","status-publish","has-post-thumbnail","hentry","category-banking","category-digital-banking","category-e-finance","category-finance","category-fintech","category-loans","category-peer-to-peer-lending","category-peer-to-peer-loans","category-student-loans"],"connected_submission_link":"https:\/\/d3.harvard.edu\/platform-rctom\/assignment\/digitization-challenge-2016\/","yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.3 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Lending Club: Can technology fundamentally disrupt how we invest and borrow? - Technology and Operations Management<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/d3.harvard.edu\/platform-rctom\/submission\/lending-club-can-technology-fundamentally-disrupt-how-we-invest-and-borrow\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Lending Club: Can technology fundamentally disrupt how we invest and borrow? - Technology and Operations Management\" \/>\n<meta property=\"og:description\" content=\"Banking has been around for 700+ years, and is the third most profitable sector in the economy. 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