P2P lending may hit banks' profits

An information technology worker in his 50s, Mr Israel is one of a growing number of people pocketing a piece of the major banks' healthy profits, by lending their savings directly to borrowers and charging interest.

He's doing it via the internet, on platforms that allow investors to lend their cash to consumers for expenses like a new car, a holiday or a wedding.

Known as peer-to-peer platforms, these websites don't have to pay for sprawling branch networks or hold billions of dollars in capital like banks do, allowing them to offer lower interest rates for personal loans or small business loans.

Investors such as Mr Israel are able to charge interest rates of 7 to 9 per cent, sometimes more, for taking the risk of putting their money on the line. It is not guaranteed like a bank deposit, though he hasn't had a default after lending to more than 100 borrowers.

"That $5000 to $30,000 segment is the most profitable lending in Australia," says Mr Israel, who has lent money to more than 100 borrowers on peer-to-peer lender SocietyOne since late 2012.

"The returns rival pretty much anything else in my portfolio."

For the country's very profitable major banks, however, these are returns they want to keep for themselves.

Peer-to-peer rivals, though tiny, represent yet another front in the growing competition they face from a new breed of small technology companies eyeing a cut of a concentrated industry that made more than $28 billion last year. We have been hearing for years about the growing competitive threat to banks from "digital wallets" - the likes of Google trying to take a cut from the payments system.

Now small technology-based firms are eyeing banks' vast loan books in consumer finance and small and medium business lending. These are markets where the Australian banks have almost $250 billion in loans, according to consultancy Digital Finance Analytics. It is not just peer-to-peer lenders. Others are trying to harness digital technology in other ways, such as promising rapid credit without the bureaucracy created by a big bank, or linking finance directly with other online services such as eBay or online classified.

For banks, this new wave of rivals is sparking a debate about how best to respond to the growing competition from technology companies that although tiny, have the potential to pinch valuable customers.

The banks' record share prices can make them appear indestructible, and the new challengers face enormous barriers in trying to enter the market, but there is a strong awareness of the power of "disruption".

Witness the upheaval unleashed by Uber in taxis, or iTunes in music.

As a senior Bank of England official, Andrew Haldane, argued back in 2012, there is no automatic need for banks if borrowers and savers could connect directly.

"The banking middlemen may in time become the surplus links in the chain. Where music and publishing have led, finance could follow," Mr Haldane said.

So, what might the wave of new online competitors mean for Australia's all-powerful banks?

Barely a week goes without a technology firm trumpeting a new offering in the finance market. With unfamiliar brand names, and often led by former bankers, these businesses are typically offering cheaper or easier credit, to an online customer base that has little need to walk into a bank branch.

Peer-to-peer lending is perhaps the most visible example. Simply put, it is where a website facilitates lending between saver and borrower - cutting out the need for the bank. It is an approach that has sparked rapid growth overseas.

In Britain, peer-to-peer lending has been roughly doubling in size for the last few years and last year its volumes eclipsed £1 billion ($1.9 billion), the industry association says. Across the Atlantic in the United States, the world's biggest P2P business Lending Club last year floated in a bumper initial public offering, with its shares surging 56 per cent on debut.

Daniel Foggo, chief executive of the Australian arm of British peer-to-peer lender RateSetter, is eyeing the $100 billion personal loan market, which includes automotive, credit cards and unsecured credit.

Ultimately, he says the peer-to-peer lenders could grab as much as 20 per cent of these markets in Australia.

While banks have argued the popularity of peer-to-peer platforms is being inflated by low interest rates, Mr Foggo points out that in Britain it has been around for almost a decade.

"Overseas there have been peer-to-peer lenders operating since 2006," he says. "Zopa [a British lender] has reported their return through that full credit cycle, and they had positive returns every year."

One reason peer-to-peer lenders like Mr Foggo are eyeing Australia is that it's an affluent, technology savvy market.

Underlining this threat to the banks, a KPMG survey this week found young customers rate the mobile and online presence as the most important attribute when choosing a bank, and they were becoming less loyal.

But the growth overseas is not just being driven by new technology or lower costs, but something much more profound: erosion in trust towards banks and large corporations.