PayPal becomes a lender and its loans are free

So I cast doubt on a survey published last week that said that PayPal is a bigger challenge to traditional lenders than challenger banks.

In the coverage I gave to the survey, I said: “which players are most likely to replace banks, rather than add on to the bank services?  I answered this a while ago, and pointed to the P2P players.”

So I stand with egg on face in some part today, as the Financial Times reports: PayPal expands lending programme to merchants.

What?

PayPal is lending?

Apparently, yes. 

PayPal is pushing to expand into the alternative lending market popularised by faster growing start-ups such as Lending Club, after already advancing more than $200m of loans to consumers and small businesses.

Ah, PayPal is going head-to-head with the P2P lenders. That makes sense, but creates an even more troublesome question for traditional banks as, in a related article in the FT, they report on Lending Club’s IPO:

Even by the standards of Silicon Valley, where large valuations of tech companies have become commonplace in recent years, Lending Club’s transition from a start-up worth a few million dollars to a public company worth $8.9bn has been astonishingly quick.

But then Lending Club has been phenomenally successful at what it does:

Lending Club, founded by chief executive Renaud Laplanche in 2006, has grown to originate more than $6bn of loans through its platform — three times the amount of its nearest competitor, Prosper.

As is the market overall:

Ashees Jain and Joseph Marra, two former Lehman Brothers bond traders based in New York, have created a fund to invest in what they see as a new booming asset class. “This year it’s going to be a $3bn origination market. In five years’ time this will be a $25bn-plus market and there will be a large institutional component,” says Mr Marra.

Mind you, P2P lending has come of age this year:

Michael Solomon spent the evening of his 47th birthday partying with Jefferies bankers at the securitisation industry’s annual gathering in Miami, Florida.  In the morning he announced a deal to sell $500m worth of the loans originated through his company – a peer-to-peer lender called CircleBack Lending – to Wall Street’s biggest broker-dealer.  Jefferies bankers now plan to securitise these “P2P” loans by bundling them into bonds that can be sold to a wide array of investors. It is the latest instance of an upstart peer-to-peer lender joining forces with large banks and investors with a view towards securitising the loans originated through online platforms.

Meanwhile, back to PayPal.  Why are they doing this?

Because they see the market as prime.  For example, commenting on the fact that Lending Club has helped investors make more than $6 billion in loans through its platform Steve Allocca, Paypal’s Head of Credit, says: “It’s just scratching the surface of what we see as the opportunity there.  This has never been a space that’s been particularly well served by banks or traditional lenders.”

That’s why PayPal has started lending, particularly to small businesses.  Their merchant lending programme was launched in September and has already made more than 35,000 loans at a maximum of $60,000 per loan.

How they do this is based upon merchants’ performance and revenues through PayPal – most of these loans are to businesses that use PayPal as their primary payments mechanism – and they collect repayments directly from sales through PayPal.  In other words, they already have the risk data from the merchant’s historical performance and can push the loans directly at merchants through a highly targeted data analytics process.

What is really interesting is that they do this with the intention of making no money from it.

You heard me: it’s free!

There’s no interest rate on the loans.

Zero.

Unlike alternative lenders such as Lending Club or small business-focused Kabbage, PayPal does not look to make money on the lending itself. Rather, it is a way for PayPal to give consumers and merchants an additional reason to use PayPal over rival payment processors, says Hill Ferguson, the company’s chief product officer.

In other words, PayPal can lend for free and just charge a set-up fee for the loan, because they want to drive more transactions through the PayPal network.  Volume and value of payments processed is what will make PayPal attractive, when it goes through its own IPO process as it splits from eBay.  

Does this mean that Visa, AMEX, China UnionPay and MasterCard will also start lending?  Probably.  

Should this concern banks?  You betcha.

What really intrigued me in the Financial Times article is how it concluded:

PayPal faces challenges as it prepares for life on its own, analysts say. It handled $180bn of payments last year, more than newer rival processors such as Stripe and WePay, but analysts and its own executives say its older systems make it difficult for the company to innovate quickly in areas such as mobile commerce.  As a result, some newer start-ups have bypassed PayPal. So too did Apple, which tapped Stripe instead as one of its partners for launching its new mobile Apple Pay service.

Wow!  PayPal is already being outstripped because its systems are out-of-date.

So, in conclusion, we have PayPal challenging P2P lenders by offering small businesses free loans whilst PayPal is being challenged by new start-ups like Stripe because its systems are out-of-date.  Meanwhile, banks think little has changed and are still running core systems built before PayPal was even born.  Hmmm … food for thought here.