Magic? No, Efficiency

Most of the time, lending institutions claim exceptional results are made possible through “better risk management.” In other words, they would have you believe that they have a competitive advantage, rooted in their ability to carry relatively higher performing loans with relatively higher interest rates.

While it is easy for many of us in the lending business to imagine a future where new data points are available to support sophisticated lending risk assessments, we’re all currently limited to evaluating a handful of data points, and lending decisions are made primarily on the quality of one’s credit history. FICO scores and the like make today’s lending risk assessment straightforward, and accessible to any kind of lending institutions

This isn’t “magic!” This isn’t something that’s really hidden from the public.

Given that, institutions looking to minimize lending risk only have one option: to focus on borrowers the industry perceives as being safe (those with idyllic credit histories). Unfortunately, for lenders, that means charging lower interest rates and earning less money on outstanding loans.

Is that achieving “superior results”? Not really.

So, all things equal, if not through risk management, then what can give one lending institution a competitive advantage over others? We think it all comes down to operational efficiency. In other words, if a lender is able to spend less to sustain business operations, this is less money taken out of loan payment and therefore from investors’ returns. This is, simply, less friction.

This gives marketplace lending firms a huge and long-lasting advantage over traditional lending institutions. For example, while marketplace lending institutions, such as Lending Club or Funding Circle, are leveraging the Internet and new technologies to bring customers and investors together, traditional lending institutions tend to rely on relatively expensive branches and are often saddled with legacy systems.

To illustrate this, see the graph below to see how firms like Citigroup and Wells Fargo compare to Lending Club, the largest marketplace lender in the US. Operational efficiency for lending institutions is pretty easy to calculate: simply divide their operating expenses by the amount of outstanding loans. According to Citigroup’s 2013 annual report, their ratio is 6.73%[1] . Wells Fargo, another large lending institution, with 6,353 branch locations in the United States, their 2013 annual report leads us to a ratio of 6.45%[2] . Both of these are in stark contrast to Lending Club’s ratio of 2.70%[3] (4.03% lower than Citigroup and 3.75% lower than Wells Fargo).

Opex Graph

At the end of the day, all institutions tout their results, it’s marketing. But, when you start to really look within a company and see how efficient they are, that’s where you’re going to notice the institutions of the future.

The big banks are getting ready to face some new competition.


  1. Only considered 2013 operating expenses attributed to Citigroup’s Global  ↩
  2. Only considered 2013 operating expenses attributed to Community Banking division.  ↩
  3. Lending Club Marketing Materials.  ↩

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