The Composite Model: A Viable Future for Online Lending

Balance Sustainable Challenge

In recent weeks, marketplace lenders have hit a rough patch. Once the darlings of Wall Street, they have now come under fire, after a string of internal scandals and disappointing earnings. For the traditional banks – who have been saying, “we need to disrupt these disruptors” – it seems the marketplace lenders are doing this work for them.

Roller Coaster VolatilityHowever, the primary mistake has not been an over-emphasis of the very real benefits that marketplace lenders can bring, including greater access to capital, speed, and efficiency. Rather, the mistake has been the belief that marketplace lenders are best positioned as viable businesses in and of themselves, instead of valuable tools serving a larger purpose and more established ecosystem. And here is where the advantages that marketplace lenders can best be leveraged – as part of a hybrid model known as composite lending.

Composite lending combines two models – balance sheet lending and marketplace lending – to deliver best of both worlds: all the benefits of marketplace lending, combined with the reliability and resiliency of balance sheet lenders.

Marketplace lenders shot into the spotlight just a few years ago, promising faster, easier access to credit than ever before, for those wanting or needing it. This was a great idea in theory, but in practice, the results weren’t always so impressive. Time has exposed several vulnerabilities in their business model, including:

Transparency: Marketplace lending platforms work by connecting borrowers with investors seeking higher rates of return (interest) than those being offered by traditional banks. After approving an applicant for a loan, a marketplace lender must get the loan off its own books and fulfill the loan request with an investor’s funding – in order to protect its own profitability, as well as its reputation. Many marketplace lenders spend millions of advertising dollars showcasing how easy and dependable it is to secure loans through them – putting their brand at stake if they fail to deliver.

For these reasons, it can be difficult for marketplace lenders to not have conflicts of interest right from the start, as they offer loans to investors. These lenders provide background on loans and risk assessments, but they are susceptible to delivering only part of the available information, or exclusively the details they want to share – because they need to get the loans off their books. They also package loans into groups to ensure that all the inventory will be sold, not only some portion of it, to the detriment of investors who are unable to align their actual fund allocations with their preferences as a consequence of this packaging.

In contrast, balance sheet lenders (often banks) don’t face the same pressures. They tend to be more diversified financial service institutions, with offerings outside of loans, such as insurance. They are used to keeping debt on their financial statements and aren’t so reliant on selling loans to investors as the only funding source. Since balance sheet lenders can accept that some loans will be kept on their own balance, there is less reason to provide overly “polished” data or force investors to buy what they don’t want to buy. In addition, new fintech platforms have emerged that are similar to marketplaces in that they are online, but very different in that they serve to connect balance sheet lenders with investors, quickly and efficiently. These new platforms also feature advanced technologies and machine-learning algorithms that assess risk on loans being offered to investors and extract all the raw data needed to provide comprehensive analysis and due diligence. This technology-enabled process raises the level of transparency that balance sheet lenders can deliver.

EggsViability: For many marketplace lenders, making loans is their only business – which may not be a bad thing, when capital is freely flowing, but can be disastrous in times when funding streams aren’t abundant. Marketplace lenders see online lending as a way to scale capital generation. If a recession or downturn causes loan requests to dry up or investors to pull back, marketplace lenders have no other reliable source of capital generation – making going out of business a probable fate.

As the saying goes, “you need to have money to make money” – and a comparison of marketplace lenders to balance sheet lenders proves this. Unlike marketplace lenders, balance sheet lenders have a primary business that involves people depositing money into savings accounts. Their lines of business tend to be diverse, both within and outside of lending. This gives balance sheet lenders a natural head start generating capital, in numerous ways, which allows them to make more loans in more diversified areas. They can then sell these diverse loans to investors, making even more money while diluting risk. This business model gives balance sheet lenders an advantage of flexibility over marketplace lenders that just grows exponentially larger.

The Nature of Borrowers: In many instances, marketplace lenders’ biggest problem is their borrowers, many of which are subprime. In addition, analyses have shown that these borrowers often borrow money to pay off debt, but then just end up accruing more debt. In good economic times, there may be significant risk, but investors may be willing to, or even want to tolerate it to chase higher yields. But in bad times, this type of strategy can be disastrous.

In an effort to grow capital, marketplace lenders may assume even more perilous risk positions, which just leads to more delinquencies and defaults and can quickly accelerate the downward spiral. Fears about stability of a pure marketplace business model – in contrast with the greater reliability, track record and diversity offered by balance sheet lenders – causes investors to seek new opportunities within the balance sheet lenders’ portfolios, and overlook marketplace lenders as the preferable investment vehicle.


Money Eyes Benjamin Look SeeAs we have noted, the advantages of the marketplace lending model are very real, and even some of the oldest, most respected names in the financial service industry are taking notice. Goldman Sachs, for example, is planning to roll out a consumer lending platform this fall, while other established lenders are planning to launch “fast decision” portals for entrepreneurs, as well as integrations with online lending portals to handle processes like credit-checking.

In contrast to prognosticators, it is highly doubtful that we are heading toward a future where marketplace lenders render traditional players – balance sheet lenders and banks – obsolete. But, neither are we headed for a state where the reliability and stability of long established lending models is no longer needed or wanted. The future of online lending is morphing into a hybrid, composite model, and it can truly be a win-win for everyone involved – consumers and small businesses wanting greater access to capital; investors seeking the opportunity to make money with an acceptable degree of risk; and balance sheet lenders looking to scale their existing, reliable capital generation to the next level.


Oleg SeydakOleg Seydak is founder and CEO of Blackmoon, a company that provides marketplace lending as a service. Oleg is responsible for choosing strategic directions, managing operations, team building, and cooperation with key partners and investors. Before Blackmoon, Oleg was a co-founding partner of VC firm Flint Capital and a Managing Director of PE&VC fund Finam Global. As a venture capitalist, Oleg originated and facilitated more than 20 deals, six of them in the fintech sphere. Oleg also served as a Project Manager at Project Finance Department of MDM Bank.

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