The Current State of Marketplace Lending in Japan
Marketplace lending growth in Japan has been slow compared to the U.S., Europe and China but that has started to change in the past three years. The market has been almost doubling each year and we expect this trend to continue through 2017. Investment volume was $140 million in 2014, $310 million in 2015 and $530 million in 2016. We estimate it to reach $1 billion this year.
Marketplace lending, also commonly referred as “social lending” in Japan, started as p2p lending around 2008 but struggled due to high default rates, which sometimes reached 30%. Since Japanese lending law prohibits interest rates above 15% in most cases, a 30% default rate was not sustainable for those businesses.
Around 2011, marketplace lending players, which at the time was just three or four companies, started to shift their focus to business loans, specifically in real estate and clean energy where there is valuable collateral behind the loan. As those players started to prove the new model was working, new companies entered the market. The number of crowdfunding platforms increased from less than 10 to 21 in two years. There are now many more companies looking to enter the market.
The industry average APR increased to 8.4% from 5.7% in two years, mainly due to newer entrants that were charging higher APRs. Default rates in the past three years have been close to zero due to platforms being more selective on who they lend money to. As a result, marketplace lending as an asset class became very attractive to investors.
From a macroeconomic point of view, Japan is famous for zero or negative interest rates. Yields for Japan’s 10-year government bond are a mere 0.06% and the 5-year bond yield is -0.07%. Average APRs for savings accounts at banks is 0.4%. Average consumers are pessimistic on Japan’s economy in the long term, due to an aging and decreasing population which is a hard trend to reverse.
So why aren’t Japanese people rushing into marketplace lending where APRs are 200 times better than savings account? Are they conservative? No they are not.
When you look at the bitcoin prices and the hype around bitcoin in the past three months (March 2017 – May 2017), it’s mainly been driven by the Japanese. JPY-based bitcoin transaction volume often exceeds USD-based transaction volume, which may be surprising. It is well known that Japan has the biggest ForEx trading volume in the world. A portion of the Japanese population do like trading and we estimate there are about 100 million active ForEx investors in Japan.
However the rest of the population are conservative investors. Despite the effort by the government to convince the population to financially prepare for their retirement, financial literacy among the Japanese population has been low for many years.
Current investors in marketplace lending are early adopters but are also cautious. There has been almost no loss of principal for three years across all crowdfunding platforms, and an 8% APR is very high. We predict that some funds will have principal losses in the coming months and some investors will react emotionally to the loss of principal since this isn’t something they are used to.
Crowdfunding platforms can do better at managing expectations, customer support, information disclosure and publicity as the platforms mature. We believe our service, Crowdport can add value to maintain transparency in the market.
Economics for Crowdfunding Platforms
Based on our research, average spread (i.e. margin) for crowdfunding platforms in Japan is 4%-5% annually. Typically crowdfunding platforms are lending at 13% and funding at 8%. Based on this margin, a crowdfunding platform needs to service portfolio of between $50 – $100 million to be break-even. Only a few crowdfunding platforms have reached this scale, however given the current market growth, many players will achieve this volume after 1-3 years of being in business.
We are also seeing some companies getting into marketplace lending from different industries. For some real estate companies, marketplace lending can be good lead generation to sell investment properties.
Almost all borrowers are businesses, with the exception of microfinance funds in developing countries. Since consumer lending in Japan is already dominated by sophisticated players known as sala-kin (salarymen + “kinyu” (meaning “finance” in Japanese)) and banks, we do not see much room for consumer lending p2p platforms.
Mezzanine loans for real estate projects consist of around 50% of origination volumes. We anticipate the variety of assets will increase as real estate prices begin slowing down.
The Lending Business Act in 2009 which limited the interest rate to 15% resulted in a massive shrink in traditional lending. In fact, the loan volume for businesses went down from $200 billion at its peak to $100 billion in seven years. The reform intended to regulate the consumer lending loan sharks but also affected business lending as well. Today, business loans are mainly lent by banks, who have less flexibility, but marketplace lenders are growing due to the unmet needs by banks.
There are no laws that govern marketplace lending. The Securities Act which secures investors and the Lending Business Act which secures borrowers conflict with each other. The Lending Business Act prohibits disclosing identity or information that might lead to the identity of borrowers while the Securities Act demands transparency on providing information on investment risks. Thus, crowdfunding platforms are operating under a vague criteria of transparency.
Recently there was an incident of a company that had taken advantage of the conflicting regulations and mislead its investors. As a result, the company was penalized in March by the authorities but it is hard to prove whether the company did this intentionally. Clearer regulation will lead to healthier growth of the industry and ultimately help the Japanese economy.
Marketplace lending in Japan is growing but the potential could be much bigger due to the need for yield and the unmet demands of banks. The lack of dedicated laws is currently preventing transparency and consumers need to be educated on marketplace lending for it become a mainstream financial product.