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Goldman Sachs’s Entry Into Online Lending

Author: Jacob Williams

Financial technology's emergence has become a disruptive force in an expanding number of financial services. Fundamental to financial technology is the link between technological advancements and financial services. As a result the customer benefits from greater transparency and accessibility to services predominantly afforded to the wealthy. Covering a number of areas, financial technology services include payments and transactions, investment management, financial planning and consumer lending, to name a few.

While still in its infant stages in the market, online lending or peer-to-peer lending has emerged as a viable alternative to commercial bank loans. In 2014, US P2P platforms issued $5.5 billion in loans. While fairly marginal compared to the $840 billion consumer loan market, online lending has expanded past small personal loans. Personal loans continue to drive P2P lending, however platforms such as SoFi thrive on refinancing student loans and mortgages. It is estimated the market can reach up to $150 billion or higher by 2025.

Recently Goldman Sachs Group, Inc. (GS) has announced its entry into the online lending space. Most commonly known as an investment bank, Goldman's newest venture may provide insight into the future of online lending. (For more, see: Technology Can Help With Student Loans.)

How Does Online Lending Work

Unlike traditional bank loans which lend their own funds, online lending platforms connect borrowers seeking loans to investors. As an easier of credit, borrowers are provided loans with rates contingent on a number of factors including the amount borrowed, credit score, and means for which funds will be used. As online lenders become more prominent and diversify into multiple asset classes, the volume of loans will inevitably increase.

Currently, lending platforms offer personal loans for home renovations, mortgages, small business expenses and financing student debt amongst many other things. Borrowers benefit from a simplified user experience, easily accessible credit and interest rates comparable if not better than bank loans. Since the whole process is conducted online, borrowers are instantly updated when their applications are approved and receive real-time updates tracking their funding. As a result the alternative finance market has grown 128 percent from the prior year. (For more, see: Peer-To-Peer Lending Breaks Down Financial Borders.)

Fundamental to this process, there must exist an investor who is willing to fund the borrower's requests. Investors can include financial institutions, banks and individuals. While online lending poses a significant threat to traditional bank loans, many banks and institutional investors have added P2P loans to their portfolios. In a recent PricewaterhouseCoopers report, the company estimates 80% of P2P investing in the US comes from institutional investors. For some investors, financial markets can be confusing and difficult to navigate. As a result lending platforms provide investors a simple process and attractive return on investment. The industry leader Lending Club Corp. (LC) boasts historical returns of 5.06% to 8.74% with various retirement accounts available. (For more, see: Investing In (And With) Lending Club: How It Works.)

Industry Leaders

Over the past five years the lending marketplace has rapidly grown with a number of companies leading the way. At the forefront is Lending Club and OnDeck (ONDK) with recent IPOs that substantiate the promise of alternative lending. In particular, Lending Club is valued at nearly $9 billion and controls a 40% share of the peer to peer market. Since its launch in 2007, Lending Club has facilitated over $9 billion in loans and growing.

Following in Lending Club's steps, SoFi is a lending marketplace focused on facilitating and managing student loan debt. Users are able to refinance or consolidate both graduate and undergraduate student loans through crowdd and investor funding. To enjoy this service, prospective users must meet certain eligibility requirements: you have $10,000 in outstanding student loans, are currently employed, graduated from an accredited university, have strong credit and consistent monthly cash flow. Since its launch in 2011, SoFi has been trusted with over $3 billion in funds. With an expected IPO in 2015, the company's estimated valuation is north of $3.4 billion.

Challenges

As online consumer lending continues to surge, for numerous reasons, there are apparent challenges that will inevitably hinder its progress. Currently, the space has been scrutinized for its relatively light regulations. Marketplace lenders, such as Lending Club, are overseen by the Securities Exchange Commission. As a result, online activity can be interpreted as a sale of a security. However the SEC primarily oversees investor protection, leaving the borrower vulnerable. Moving forward, appropriate regulations must be made by the Consumer Finance Protection Bureau in order to protect borrower's interests. As the industry continues to grow and Goldman Sachs enters into the space, greater regulation is a near certainty.

Goldman Sachs's Online Lending

Most commonly known for its investment banking services, Goldman Sachs has recently announced its entrance into the online lending marketplace. Goldman Sachs has built its reputation on identifying and seizing profitable opportunities before its competition, and this may not be any different. Operating in direct competition to industry leaders Lending Club and OnDeck, Goldman Sachs will not utilize a P2P system; instead it will act as a direct lender. The new division will operate through a website or an app, offering personal loans of up to $20,000. With low-cost structures and no physical bank branches, Goldman Sachs can lend money at lower interest rates while still procuring a profit.

Following the financial crisis in 2008, many financial regulations were implemented to create transparency in financial services. As a result, the bottom lines of many traditional banks have been affected. In light of adjusting to new regulations, recent return on equity for Goldman Sachs has dropped to 11%. Conversely, consumer loans are capable of producing a return on equity of more than 20%. As a result, Goldman Sachs's entrance into online lending, which remains largely unregulated, is logical. With innovative trends in financial technology continuing to emerge, traditional banks will continue to digitize services.

The Bottom Line

Over the past 10 years, financial technology has proven to be a disruptive force to traditional financial services. Many aspects of finance have been digitized and automated to reach the common man or woman. In particular, online consumer lending has made its presence with the recent public offerings of Lending Club and OnDeck. Operating under peer-to-peer systems, online lenders facilitate loans between borrowers and investors. Its growth comes due to flexibility, accessibility, better customer experience and comparable rates amongst many other things. With its recent influx, Goldman Sachs's has ventured into online lending. Acting as a direct lender, Goldman Sachs will launch an online lending platform within the next year. With its prestige and reputation, Goldman Sachs's entry into online lending will with certainty lead to increased regulation.

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