Online lending is having a moment.
An estimated $5.5 billion in loans (pdf) were made last year through peer-to-peer lending websites like Lending Club and Prosper, which use technology to bypass bank loans and connect borrowers with lenders online.
Increasingly, the loans are working their way into the broader financial system. Many are now being gobbled up by more traditional banks who face record low interest rates and are chasing after higher-yielding investments.
The biggest of the online lenders is Lending Club, founded in 2007 by former investment banker Renaud Laplanche.
The company went public last year and has been doubling its loans every year. But Lending Club is still unprofitable, and faces an influx of competitors. Investors worry the boom in online lending (pdf) might fizzle in a down economy or higher interest rate environment.
Laplanche, a competitive sailor who grew up in France, said he started Lending Club after turning over a credit card statement and realizing how much money banks were making off the spread from unsecured consumer loans. The idea was to use technology to make loans more cheaply, luring customers from traditional banks with lower interest rates and higher returns.
Quartz caught up with Laplanche to talk about working with the very banks Lending Club was designed to compete with, and how he is steering the company through its post-IPO phase. A lightly edited transcript follows.
Quartz: You recently partnered with mega bank Citigroup, which will lend out $150 million to borrowers through Lending Club’s online platform. The program helps Citi comply with the Community Reinvestment Act, which requires banks to lend money to people in underserved communities. How did that deal come about?
Renaud Laplanche: We work a lot with banks now and CRA often comes in conversation about something banks would like to do more of. They are having trouble reaching these populations because they don’t necessarily have branches in particular areas, so having an online platform is a way to reach them. (See separate Quartz article on how digital banking might be at odds with the CRA’s aims.)
How does Lending Club find these borrowers?
We use quite a bit of geo-targeting already in our marketing efforts so it’s something we can continue to do more of.
So you would geo-target someone based on their neighborhood and income levels?
Yes. There are regulations that prevent us from specifically targeting like that, but a lot of potential borrowers that are not qualified applicants come to us already so our software would be able to tell us if particular applicants meet the requirements for community lending and CRA and they would get the discount and loan funded through Citi.
And we’ll know exactly where they come from a geo-targeting standpoint, from their computer IP address and their physical address.
Peer-to-peer lending is often discussed as an alternative to these kinds of traditional banks. Did you expect to be working with big banks like Citi when you first launched Lending Club?
The idea of convincing the banks to work with us was pretty far-fetched. The thinking was that the banking industry considered us as competitors and would fight us. It turns out, that hasn’t been the case.
So Lending Club chooses and assesses the borrowers and originates the loans, but then the traditional banks lend out the money and potentially package the loans up and sell them to outside investors, right?
It sounds like the banks now get rid of a bunch of risk (like giving out loans to people they know can’t pay them back or ignoring certain groups of borrowers), but retain the financial rewards.
I don’t know if the banks don’t have to worry about the risks. There are a lot of cases where we partner with the banks. There are a lot of audits and scrutiny that goes into the origination process. The way the loans transfer to the banks, which have to report to regulators and represent that the loan was made in accordance with rules and regulations. So I don’t know if banks take less risk by working with us; I think it’s more a cost reduction.
How will Lending Club be able to withstand another financial crisis? While you were around in 2008, you were much smaller back then.
We were smaller but the loan portfolio was statistically significant so it doesn’t mean the learnings are any different. Today, each time we underwrite and price a loan, we also run it on the 2008 model and see how it would have performed at the time. Launching in 2007 gave us a really big advantage over the new players because we have so much more valuable insight on what happens when the unemployment rate goes from 5.5% to 10.5% over a short period of time.
It’s like your own stress test?
Exactly. It’s really valuable data to have and a good proxy of what would happen in the next cycle. I’m hoping that all the improvements in risk management we’ve done over the last eight years would put us in a better position in the next cycle than we were in 2008 even if we didn’t learn anything in the last eight years.
Is there a role for Lending Club to play in making sure the burgeoning online lending industry—and its customers—survive another financial crisis?
Renaud Laplanche: We are working with the industry to create a borrower bill of rights that will set standards in terms of compliance and consumer friendliness. The next step would be to create a trade association that also sets standards for the members in terms of risk management, compliance, and financial stability.
You recently talked about bringing the concept of Lending Club into physical stores. How far off is that idea?
It’s a concept right now, something we are testing and playing with. The problem we are trying to solve is how to make credit available where people need it at the point of sale in the way that’s more convenient than the way it’s done today. There are many opportunities in student lending, auto lending, and mortgages.
You took Lending Club public last year. What’s your advice to other startups contemplating an IPO?
There seems to be a higher level of confidence, trust, and a sense that we’re here to stay.
I was worried about the ability to recruit top talent after our IPO because people might think most of the value has already been created. Now we attract people by showing them they can do something meaningful with their life and help transform the industry. Plus, now that we are public, the situation has been de-risked.
We’ve proven the model, we have a billion dollars in the bank, we can sustain a lot of different things not going our way if we had to, but at the same time, there’s a lot of the growth ahead.