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Is online lending in danger of a shut-down?

Woes at LendingClub are prompting speculation about the future of the P2P phenomenon.

The growth of the online lending industry has been characterised by youthful exuberance in the post-crisis years.

With banks cutting back on lending, numerous peer-to-peer (P2P) platforms were launched to offer quick and easy financing to small businesses and consumers. It was the place where tech entrepreneurs met financial innovation. New platforms kept launching, rapidly building their businesses, with several going public to much fanfare.

Platforms announced rounds of equity or debt financings from well-known alternative investment firms, financial industry hot-shots and banks. The people speaking about the draw of online lending at conferences almost had a religious zeal about them.

Fast forward a couple of years and some of the major online lending names have got into trouble. LendingClub, the largest and most well known online lending firm in the US, recently removed its chief executive, Renaud Laplanche, after revealing it had received a subpoena from the Department of Justice related to “defective controls”. The investigation was tied to ineffective disclosures and risk controls, with a package of shoddy loans totaling $22 million sold to a single investor.

Needless to say, the news was a huge blow to LendingClub and the online lending industry overall and several law firms are now pursuing class action lawsuits against the firm. Its stock quickly dropped from $7 per share last week to about $3 – $4 per share as of 18 May.

Moreover, LendingClub’s travails aren’t the end of the story. Prosper, another large and popular online lender – and whose name was never intended to be ironic – announced job cuts equivalent to 28 percent of its workforce recently. The firm’s stock price has been declining as it has failed to sustain the aggressive growth plans it had put in place in the last few years.

Blackstone, which last year announced plans to expand into online lending, has reportedly culled those ambitions now, with some of the executives that were hired for the effort having left, according to Bloomberg.

Naturally enough, many players in the sector are probably now wondering what these high-profile stumbles mean for them.

Amid all the enthusiasm, there has always been skepticism. After all, online lenders often advertise the ease and speed with which they can grant loans to applicants online. But if it’s really as easy as the click of a mouse, one wonders how much diligence these platforms are doing on the borrowers’ credit worthiness.

Investors looking at these platforms have pointed out to us that they may have an agency-and-principal problem, where many of them are effectively conduits between investors and borrowers and don’t hold any of the loans or risk on their balance sheets.

Some of the fears have materialised, although online lending is now such a huge well-oiled machine that it’s unlikely to just disappear with these recent difficulties. Industry experts have been predicting that the industry had yet to reach a maturation phase, and this might just be it – a time when some lower-quality or poorly executed models go out of business.

Closer attention and perhaps more standardisation is needed when it comes to risk controls and vetting borrowers. Ultimately, the industry can’t keep growing at the same rate that it has. Some of it needs to be shaken out and better constructed, lest the whole online lending phenomenon disappears as quickly as it sprang up.