Small Business

With LendingClub Scandal, It's Time to Take a Closer Look at Marketplace Lending

LendingClub was supposed to revolutionize how people got their loans, but is it really what it seems? Here's what happens when the hype around a novel company starts to die down.

In May 2016, LendingClub, a marketplace lender, fired its CEO, Renaud Laplanche, amid questionable lending practices and a conflict of interest in one of Laplanche’s personal investments. To add fuel to the fire, LendingClub postponed its annual shareholder meeting in June. Unsurprisingly, LendingClub’s stock price has plummeted and some investors have begun pulling out of the service.

Marketplace lending, also referred to as peer to peer lending, allows individuals to borrow money online from peers or institutional investors, removing banks as the middle men in the lending process. Though marketplace lending began before the financial crisis, it has gained popularity in recent years. Initially, marketplace lenders only let individual investors and borrowers use the platform, hence the name peer to peer lending. As the market grew, the investor base grew to include institutional and large investors.

Marketplace loans gained popularity because they have higher yields, shorter durations and little to no correlation with the stock market. However, the LendingClub scandal has raised some questions about the viability of the market for these lenders.

According to Bloomberg, many individuals who borrow money through marketplace lenders do so to refinance existing debt. Investing in LendingClub or a similar platform means you are buying unsecured consumer loans, which are a fairly risky investment. Despite the risk, marketplace lenders have enjoyed a relatively stable, growing market the past few years. They have yet to prove themselves in an economic downturn or bad market. How will they handle an increase in the default rate of their loans when there is a downturn? Will marketplace lenders be able to continue operating?

Moreover, marketplace lenders aren’t subject to the same regulations as banks and therefore don’t have a minimum amount of deposits to keep in cash. This means that they can operate at a lower cost, but this also exposes them to funding risk if investors pull their money out.

There’s also been debate as to whether marketplace lenders are reinventing lending or if they are just technology platforms. Some P2P lenders, like LendingClub, claim to use a proprietary model to evaluate potential borrowers. However, many simply use a borrower’s FICO score, which isn’t an improvement on the existing loan application process -- these lenders just provide an automated, online underwriting process to facilitate loan applications. Information from borrowers is also self-reported, which opens up another set of problems. Even if the P2P lenders try to verify this information, how confident are they that their borrowers’ information is accurate?

These problems were brought to the forefront with the LendingClub scandal this year. LendingClub sold loans to an institutional investor that did not comply with the wishes of the investor, and furthermore, Laplanche failed to disclose a personal investment in a company that LendingClub was considering investing in. With tanking stock prices and investors beginning to pull out of the platform, this could spell disaster for the company, and it may even signal rough times ahead for the industry as a whole.

Justin Song

Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.