Striking a Balance between P2P Lending Regulation and Innovation
Promoting responsible lending practices on online peer-to-peer platforms builds market trust and deters the need for further regulation.
Peer-to-peer (P2P) lending, which allows the public to lend money and earn an interest through an online platform, is growing fast in the Republic of Korea. It has however strayed from its initial course as the share of secured corporate lending grew sharply.
The supervising authority in the Republic of Korea has introduced P2P lending guidelines. But without legally binding power, the guidelines have had limited effect on deterring undesirable lending practices. With efforts underway to establish a stronger legal framework, P2P firms and investors need to practice more responsible P2P lending to build market trust, which would in turn, reduce the need for regulations.
In the Republic of Korea, the cumulative amount of online P2P lending grew sharply from 339.4 billion won (more than $280 million today) in end-October 2016 (234.0 billion won outstanding) to 3.63 trillion won (1.09 trillion won outstanding) in end-March 2019 for the 44 member companies of the Korea P2P Finance Association.
P2P lending is attracting much attention as a profitable investment opportunity and as a possible alternative to traditional lending channels.
According to the Financial Supervisory Service, there are 205 P2P firms as of end-September 2018, with cumulative lending of 4.3 trillion won (1.7 trillion won outstanding). Only 59 of these companies are members of the Korea P2P Finance Association and their cumulative lending amount stood at 2.68 trillion won as of end-September 2018.
Membership to the Korea P2P Finance Association is not mandatory and data on nonmembers are not easily available. This article focuses on member companies of the association for ease of analysis and comparison.
Figure 1: Cumulative Amount of P2P Lending
Initially, P2P lending was introduced to supply relatively cheaper funding to financially vulnerable consumers. Yet, the share of unsecured lending remains low and the volume of corporate lending is 1.8 times greater than individual lending. The cumulative amount of unsecured P2P lending stood at 134.8 billion won in end-March 2019, accounting for a mere 3.7% of all P2P lending. Secured corporate lending represented a whopping 32.5% of all P2P lending. The gradual increase of institutional investors and corporate borrowers on P2P platforms has been also observed in the United Kingdom and the United States. In these countries, the term “marketplace lending” has replaced “P2P.” It should be noted however that in these countries, institutional investors rarely take part in P2P platforms directly, and mostly engage in purchasing qualified loans.
The average delinquency rate of P2P lending is 7.07% in the Republic of Korea, but the rate varies widely by firm. Among members of the Korea P2P Finance Association, 20 companies have zero delinquency rate; three companies have more than 60% delinquency rate; 8 members, more than 30%; and some have 100%. What’s worrisome is that the amount of real estate-related lending represents 53.2% (or 1.9 trillion won) of all P2P lending, raising concerns over their quality in case the housing market slumps.
The Financial Supervisory Service put together P2P lending guidelines in 2017 for investor protection. However, investor loss has frequently occurred because of undesirable or illegal lending practices and the guidelines lacked legally binding power. The guidelines call for improving information disclosure, encourage separate management of invested funds, and cap the amount of individual investors’ maximum lending to a single borrower at 5 million won as well as the cumulative lending amount at 10 million won.
In June 2018, the Financial Supervisory Service undertook a survey of P2P lending practices to better deal with investor losses. It set out to establish a strong legal framework to promote sound P2P lending practices. It inspected 178 P2P companies, and requested the Prosecutor’s Office to investigate companies with allegations of fraud or embezzlement. Further, to improve the effectiveness of the guidelines, compliance was linked to the granting of a P2P business license and registration.
For fintech businesses, it is important for pioneering firms to ensure sound risk management to build market trust, rather than relying on regulations as they might artificially raise entry barriers for latecomers. UK’s pioneering P2P companies, especially Zopa, initially set a maximum amount for each investor as well as for each borrower, but later discarded this restriction as the market grew to a substantial size. It is desirable to minimize regulations to stimulate innovation of fintech firms, and to do so, P2P firms should endeavor to establish sound business practices voluntarily. On the part of investors, they need to be responsible for their actions by, for instance, only dealing with P2P firms that follow sound business practices.
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