The Bank of Israel has expressed concern about the functioning of direct loan platforms (P2P) in the event of an interest rate hike or an economic crisis. "The platforms have yet to encounter a financial crisis," the Bank of Israel writes in its annual report for 2017, which will be published in full next week. "The big challenge facing the credit platforms is to continue operating when the interest rate in the economy rises, together with the insolvency rate. Their success in this depends on the success of the risk assessment models that they have developed," the Bank of Israel adds.
The P2P sector is experiencing worldwide growth. The Bank of Israel, however, reminds people that during these years of growth, the global economy has been in the positive part of the business cycle, and interest rates have been low. What will happen to these platforms when the trend reverses is an open question.
The Bank of Israel presents a number of reasons for its concern. The first is that when the interest rate rises, the return offered to lenders by the platforms will not be attractive enough in comparison with the banks' alternative. "In a higher interest rate environment, the banks' advantage will be more significant. Since most people are risk averse, when the interest rate is higher, investors are likely to prefer a bank deposit providing a reasonable interest rate with no insolvency risk to the financing of risky loans," the Bank of Israel writes.
The Bank of Israel also expresses concern about more cases of insolvency in a crisis. "If the default rate on loans through online platforms increases, concern over investing in them will increase, and lenders will demand an even higher interest rate. In general, the platforms are more sensitive to changes in the reputation of each company separately, and of the sector as a whole. In contrast, depositors in banks are not sensitive to cyclical changes in the banks' credit losses because of the capital reserve maintained by the banks and confidence in supervision of their stability."
The Bank of Israel states that while the platforms disperse the loans, thereby reducing the exposure risk for individual loans, "Nevertheless, this does not provide protection against an increase in the systemic risk for the entire economy. The same is true for the insurance mechanism that they offer - if the rise in the insolvency rate is significant, their credit losses are liable to exceed the amount accumulated in the reserve fund," the report says.
Will they compete or complement?
Online loans are experiencing a global boom. "The worldwide balance of credit through online financing platforms is negligible compared with the overall credit market, and currently does not pose a threat to the conventional banking system, but the growth rates of this credit are very high," the Bank of Israel writes, noting that the growth rate in the various markets was over 100% in 2013-2015. "Over the past two years, growth rates in online credit in the developed world stabilized somewhat: 22% in the US, 43% in the UK, and 41% in Europe in 2016." The report goes on to say that the figures show that China is now the biggest market in this sector. The volume of credit in online loans in China soared to $195 billion in 2016, and more than doubled within a year. In Israel, on the other hand, this market is just getting started. Bank of Israel figures indicate that the volume of loans on the platforms amounts to NIS 500 million, 0.3% of total consumer credit in Israel.
The Bank of Israel states that one of the factors in the sector's growth is the platforms' positive image: "Online platforms are perceived by the public as ventures that contribute to 'social justice,' in contrast to the worldwide negative image attached to the banking system following the financial crisis. The reason for this positive image is that investors can benefit directly from the interest paid on the loans, without the banks taking a share of the profit."
P2P companies are regarded as the banks' competitors in credit, but the Bank of Israel believes that in the long term, neither player will triumph over the other; there will be room in the market for both types. "The most likely scenario is one in which both the banks and these concerns either operate as competitors or complement each other. The user experience and the technology that the online intermediaries have developed are likely to force the banks to streamline, and to invest in technological improvements, as has indeed been happening in recent years. This is a welcome result of the rising competitive threat," the Bank of Israel writes.
P2P platforms in Israel are in a process of registration and supervision. Meanwhile, the companies are complaining about a problematic attitude on the part of the banks, which are obstructing their activity. In view of the lack of regulation in these relations, tension and differences of opinion have also emerged between the Bank of Israel, which supervises the banks, and the Capital Markets Authority, which is due to begin supervising the loan platforms. This question has even reached the Knesset, which is trying to find a solution for the issue.
Published by Globes [online], Israel Business News - www.globes-online.com - on March 22, 2018
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