A

s digital technology penetrates almost every process in business activities, we could hope for a quicker, cheaper and simpler process that will speed up decision-making and enhance the quality of the process and the outcome.

Regarding loan applications, imagine that we can apply for one just by entering a few bits of information into an online portal and the loans will be approved and received within hours, or only several days. This has been made possible by the presence of an online platform that makes borrowers and investors meet and go through the lending approval process with a simpler administration process and quick lending decisions, with low interest rates. This model is called peer-to-peer lending (P2PL).

Originally, P2PL was focused on the crowd lenders, known as crowdfunding. Most borrowers were purely seeking to refinance their existing high-interest debt, such as credit card loans. On the other hand individual investors, who only earned low returns from their bank deposits or faced higher risk in the volatile stock market, were looking for other investment alternatives that could balance their expected returns with accepted risks. In the meantime, returns obtained by individual investors attracted institutional investors to join the scheme by investing the capital as well (especially in the US), so that institutional investors like hedge funds banks and large institutions later became investors.

The marketplace lending industry continues to grow as global marketplace lending is predicted to reach US$290 billion by 2020, growing by 51 percent in a compound annual growth rate (CAGR) from 2014 through to 2020, according to Morgan Stanley research. In the US, loans issued through the P2PL platform in 2014 reached $5.5 billion. The markets that are mature enough for marketplace lending, among others, are the US, the UK and China.

Several factors contribute as keys to success, particularly in a developed market. These include strong adoption of online or mobile banking, a benign regulatory framework for marketplace lending, low customer satisfaction with incumbent financial institutions and high existing penetration of unsecured credit (such as credit card debt).

In the US, credit card debt refinancing has helped establish P2PL companies, like LendingClub. Meanwhile, availability of credit information (for instance through a central credit bureau) to facilitate an automated approach to credit scoring was also a help. In general, P2PL will potentially evolve in the market where the usage of mobile banking and credit card penetration is relatively high.

Nowadays, there are many marketplace lending platform providers in Indonesia that are emerging, offering a marketplace for borrowers and investors to reach agreements on lending needs. We can find attractive commercial ads displayed on a website like: “Indonesia is a big economy, yet access to finance is very limited; why don’t we offer something different?” or “Everybody can now invest in Indonesia’s best SMEs.” Yet, as experienced by other countries, there are several things that need to be settled in order to provide a better ground for the P2PL industry to flourish in Indonesia.

The first is related to data infrastructure. As mentioned above, the availability of credit information is very important for the platform to have a credible reference to calculate a borrower’s credit score to be able to determine the right yield associated with the risk level. Unlike in the US or the UK, currently there is no third party credit score provider (like FICO in the US or Equifax in the UK) in Indonesia. We only have a credit bureau that is being administered by the central bank that provides a raw database of debtors in Indonesia, which is only accessible by entities with a banking license. That database is different because it does not actually give information about credit ratings, just bare information.

As a consequence of the lack of data infrastructure, investors will tend to ask for higher yields to compensate for the greater risk. Therefore, it is reasonable if many P2PL companies in Indonesia aim to focus their business on funding SMEs rather than individual borrowers since they can get more information on SMEs. If a P2PL company is unable to accurately and properly assess and represent the risk of a borrower to an investor on the platform, the P2P platform won’t last long as trust in a financial marketplace is fragile. In China, to solve this problem, they combine an online appraisal incorporated with an offline approach, but this will lead to higher operating costs.

The second is related to liquidity. To make an investment in marketplace lending become more attractive, there is a need for a secondary market that will facilitate investors to do secondary transactions (to sell and buy the loans and securities). This is already established in the US — for instance LendingClub partners with Folio Investing (an online brokerage offering financial resources and investment products) to facilitate secondary trading of loan notes. Instead of waiting for the loan to be due, investors can transact their assets, secure the certain return and get back the principle. This will give confidence to investors and in the long run will be able to help lower the yield required because of the lower risk perception. Hence, it will attract demand from borrowers and supply from investors.

The third is related to regulations. Until recently, there were no regulations in Indonesia that specifically regulated this business model. Therefore, the rules and protection for both borrowers and investors from related risks or fraud either intentionally or through mere negligence were not available.

The regulatory environment differs from region to region. For example, in the UK, regulators quickly developed rules for marketplace lending by establishing the P2P Finance Association (P2PFA) as a self-regulatory body that promotes high standards of conduct and consumer protection, while in the US, regulators have taken a largely hands-off approach. P2PL companies operate under all applicable federal and state securities, banking and lending regulations, as well as under consumer protections laws. However, these laws and regulations were not enacted specifically to address marketplace lending.

Despite the infancy of the industry, as it has already taken place in Indonesia and would potentially slowly disrupt the conventional practice of lending provided by traditional banks, they should be able to respond through strategic actions in the future. One of the reasonable options is to establish a partnership with a P2PL company by investing in the P2PL’s platform, or to utilize the platform for channeling capital as an institutional investor. The other one is, instead of building a partnership, banks can stand to challenge the platform by offering more competitive products through more innovative channels that are targeted at the P2PL’s market as well, so as to defend and moreover enlarge the current market share. Given the massive technological disruption and shifting consumer behaviors, which option is the best one?