TORONTO – They are the frenemies of the financial services world.
Shadow lenders fuel risk in Canada’s hot housing market
Shadow lenders who operate outside the reach of regulators are thriving in Canada — creating a risk the Bank of Canada says could spill into the broader economy. Read on Depending on whom you speak to, marketplace lenders are either driving innovation through technology to make the loan process faster and easier, and disrupting the cozy and profitable business of traditional banking, or they are the latest threat to the stability of the financial system.
In the past six months, a growing number of non-bank loan companies — sometimes called peer-to-peer lenders because they match people and companies seeking loans with investors prepared to make them — has sprung up in Canada. Some migrated from successful platforms in the United States, while others have been launched here based on the successes of similar ventures such as Lending Club in the United States, Europe and the United Kingdom.
Borrowers in Canada who used to knock on the doors of the big banks and then have to wait weeks for an answer are now able to tap funds more easily through online technology-driven lenders, such as Grouplend, Borrowell, OnDeck and FundThrough, which quickly compile online data and use algorithms to assess risk and match lenders to borrowers.
Related Bank of Canada should monitor ‘shadow’ sector, Wilson says Getting a loan may prove elusive for millennials in contract work Fraser report downplays debt risk in Canadian marketplace Peter J. Thompson/National Post Peter J. Thompson/National PostAndrew Graham, the co-founder and chief executive of Toronto-based Borrowell, at which interest rates start at 5.9 per cent, pegs the size of that potential market at about $82 billion. Yet, everywhere they go, there are murmurs about the risks that may be posed by these new businesses operating outside the strict regulations imposed on banks.
Their proliferation is due to a combination of factors: the wealth of information online and the rise of the “shared economy.”
Marketplace or peer-to-peer lending is poised to become the Uber of financial services, says Kevin Sandhu, the chief executive of Vancouver-based Grouplend. Except, instead of challenging the taxi industry by accessing the cars many people already own to get other people around town, peer-to-peer lenders use money people who already want to invest to fund the loans other people want — at a mutually agreed upon interest rate.
Don MacKinnon for National Post Don MacKinnon for National Post Kevin Sandhu, Grouplend CEO, aims to take on the big banks through the new “shared economy.” “Money’s a lot the same” as the individual’s car entered into Uber’s service or a condo that gets rented out as a vacation spot for tourists on Airbnb, said Sandhu.
Instead of passengers or vacationers, though, borrowers are on the other side of the loan transactions, looking for money they can’t get from a bank or can only get at a higher interest rate.
“We have all these investors who have capital, they want to invest it, they want to earn a return on their savings,” Sandhu said. “Rather than go through the intermediary of a bank or traditional institution, why not directly connect the two, cut out the middle man, and all the cost savings that come about are shared with parties on both sides.”
Toronto-based FundThrough is trying to do much the same thing with business suppliers, using the online assessment and investor funding formula to “factor” or make loans against accounts receivable based on the strength of the businesses buying from the supplier.
Executives at marketplace lenders say a lot of what they do doesn’t compete directly with the big banks because the loans they give are too small, or they go to people who wouldn’t meet a bank’s strict qualification criteria to secure a loan, such as home ownership or business history.
“We like to think that our technology — we have a very data-driven approach — results in more smart ‘yeses.’ So, saying yes where others would say no but they should have said yes,” said Rob Young, senior vice-president of international operations for New York-based small business lender OnDeck, which expanded into Canada in April.
Borrowell’s lending homepage at www.borrowell.com Borrowell’s lending homepage at www.borrowell.com But in some cases it’s clear that banks stand to lose, particularly in lucrative business segments such as credit cards.
Borrowell, a service that went live in March with the backing of mortgage loan company Equitable Bank and investors including John Bitove, specifically targets people who carry credit card debt. The new service promises much lower rates than the 19.9 per cent interest or higher charged for balances on many cards.
Andrew Graham, the co-founder and chief executive of Toronto-based Borrowell, at which interest rates start at 5.9 per cent, pegs the size of that potential market at about $82 billion.
People who are carrying credit card or other debt and looking for lower interest rates also make up a big chunk of the business at Grouplend, which targets retail borrowers, said Sandhu.
I didn’t fit into their little model of what a good loan customer would be. So I went elsewhere A Toronto lawyer who took out a loan through Grouplend said in an interview she faced a “hostile response” when she first approached her longtime bank to try to refinance $20,000 in debt she was carrying in an overdrawn account at another large Canadian bank. Speaking on condition that her name not be used because of the sensitive nature of her situation, the 41-year-old said she racked up the debt, which carried a double-digit interest rate, when she had to take a year off work for health and personal reasons.
When she returned to work, she approached another major Canadian bank to try to address her situation.
“Not having assets [such as a house], I didn’t fit into their little model of what a good loan customer would be,” she said. “So I went elsewhere.”
She said she found Grouplend through a Google search, applied for a loan online to pay off her other debt, and was offered three years to pay back the new loan at a “much better” six per cent interest rate.
Since launching late last year, Grouplend has received applications for $65 million in loans.
To be sure, peer-to-peer lending is in its infancy in Canada — San Francisco-based Lending Club has funded more than US$9 billion in loans. New and existing players would have to become “quite a bit bigger” before threatening any real damage to the big banks’ bottom line, said Graham, who co-founded Borrowell after working as an executive on the insurance side of President’s Choice Financial.
But it is clear the major institutions are taking notice.
Canadian Press Canadian PressRegulators need to consider if the safety and soundness of these new players matters to the stability of the whole financial system: TD CEO Bharat Masrani. Bharat Masrani, the chief executive of Toronto-Dominion Bank, didn’t use the word “frenemy” during his annual speech to shareholders in late March, but he touched on what he viewed as the benefits and threats of non-traditional players “opening up new frontiers in banking.”
He spoke about the “benefit from more choices” inherent in competition,” but urged regulators to ensure there are adequate rules and a level playing field to protect consumers, shared payment systems and markets.
“Regulators will also need to consider if the safety and soundness of these non-traditional players matter to the overall stability of our financial system,” he warned.
Marketplace lenders exist in a world outside the heavily regulated banking sector. In Canada, they are bound by provincial consumer protection rules dealing with privacy and interest rates, as well as securities regulations if high-net-worth investors are funding the loans. But these new lenders aren’t under scrutiny by Ottawa’s rule-heavy bank regulator, the Office of the Superintendent of Financial Institutions.
Detractors throw around words such as “shadow banking” for this world, with the implication that dangers lurk in this dark and secluded area of the financial services.
The hard part is, I don’t think we’ll really know until there’s a downturn and we sort of test the system Bob Dannhauser, head of capital markets policy at the CFA Institute in New York, a global association of investment professionals, said marketplace lenders are part of the shadow banking sector. But he said regulators and policy makers are among those trying to gauge whether they are a net benefit or a new unmeasured risk to the system.
“The hard part is, I don’t think we’ll really know until there’s a downturn and we sort of test the system and test how durable their underwriting criteria are,” he said.
Canada hasn’t embraced the full-on crowdfunding version of peer-to-peer lending that has taken hold in the U.S. and Europe because regulations limit the fund sourcing to institutions or wealthy individuals also known as “accredited” investors.
“I think that’s sort of an accident of history — I’m not sure there’s been any particular initiative to proactively limit it to that,” said Dannhauser, who adds that the field could ultimately be opened up to regular retail investors.
“I think as crowdfunding vehicles take off, particularly in Europe, where I think it’s off to the fastest start, there might be some pressure,” he said.
The U.S. and Europe can also offer a sense of how the big banks may react to the new players. Jamie Dimon, the chief executive of JP Morgan Chase & Co. got a lot of attention last month when he praised the new players for using Big Data to “enhance credit underwriting” and speed up loans, adding that his bank plans to work hard to match their services and is “completely comfortable” partnering where it makes sense.
“The banks have kind of turned around a bit the last couple of years from ignoring us or thinking [we’re] going to go away,” said Young, noting the established players paid little attention when OnDeck launched in 2007. The company grew and ultimately attained a listing on the New York Stock Exchange.
Now, some U.S. banks have already forged partnerships through which they refer their customers directly to OnDeck. One banking partner is BBVA Compass, which has 688 branches in seven states and ranks among the Top 25 largest commercial banks in the U.S. based on deposit market share.
“Just like we do in the U.S. we’ll most likely be doing partnerships up here [in Canada], whether it’s accounting solutions [or] potentially some of the banks,” said Young, who added plans are under way to open a Canadian office in Vancouver or Toronto.
Borrowell is already working with federally regulated Equitable Bank, which is funding the new consumer loans and is also an investor. And executives at the marketplace lenders in Canada said they are not opposed to partnering with traditional financial institutions.
But how the big Canadian banks choose to play the game depends on whether they look at their marketplace frenemies and see more potential as a friend or an enemy.
“Large banks, that’s exactly what they’re trying to figure out,” said Borrowell’s Graham.