Evolution of Credit and Lending Practices

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Questions and Answers

What year was the Federal Home Loan Bank System established, marking a foundation for U.S. residential mortgage lending?

1932 (correct)

1950

1930

1940

Which credit card was introduced first as part of the evolution of credit in 1950?

American Express

Diners Club Card (correct)

MasterChargecard

BankAmericard

What significant innovation in lending was first introduced in 1961?

Freddie Mac

BankAmericard

Online mortgage applications

Reverse mortgage (correct)

What does P2P stand for in the context of financing?

Peer-to-Peer Signup and view all the answers

Which organization was established in 1970 to create a secondary market for traditional mortgages?

Freddie Mac Signup and view all the answers

What technological advancement in lending was introduced in the 2010s?

Digital wallets Signup and view all the answers

What is the primary purpose of P2P financing as described in the content?

To provide access to financial services for financial inclusion Signup and view all the answers

In what year was the concept of credit scores first adopted to help lenders assess creditworthiness?

1959 Signup and view all the answers

What is one major benefit of P2P platforms for borrowers in terms of eligibility?

P2P platforms often have less stringent credit requirements. Signup and view all the answers

How do P2P platforms typically manage their operational costs?

By operating without the physical infrastructure of traditional banks. Signup and view all the answers

What feature of P2P lending allows borrowers to tailor their financial experience?

Customisable loan terms and repayment options. Signup and view all the answers

What aspect of P2P platforms promotes transparency for borrowers?

A clear breakdown of fees and interest rates. Signup and view all the answers

Which entities are specifically prohibited from raising funds through a P2P platform?

Public listed companies and their subsidiaries Signup and view all the answers

What is a potential advantage for lenders who invest in P2P platforms?

Higher returns than traditional savings accounts. Signup and view all the answers

What mechanism was introduced by the SC in 2020 for ECF and P2P?

A secondary trading framework Signup and view all the answers

How quickly can borrowers expect to receive funds from many P2P platforms after approval?

Within a few days. Signup and view all the answers

What is a defining characteristic of alternative financing?

It provides capital outside of conventional banks. Signup and view all the answers

What do lenders gain access to when investing through P2P lending platforms?

A variety of loans with different risk ratings. Signup and view all the answers

How does the Malaysia Co-Investment Fund (MyCIF) operate in terms of investment ratio?

MyCIF invests RM1 for every RM4 raised by others Signup and view all the answers

Which of the following is NOT a benefit mentioned for borrowers using P2P platforms?

Higher interest rates compared to traditional banks. Signup and view all the answers

What is the maximum amount the MyCIF can co-invest in a single campaign?

RM1 million Signup and view all the answers

Which of the following is NOT a method of alternative financing?

Fixed deposit lending Signup and view all the answers

Which of the following is true regarding the eligibility of investors for P2P funding?

Only individual investors are allowed to participate Signup and view all the answers

In invoice financing, what percentage of the total accounts can a factor typically pay upfront to the business?

70% to 90% Signup and view all the answers

What role does a factor have in the invoice financing process?

It conducts a creditworthiness assessment of the customers. Signup and view all the answers

In which year was the MyCIF first announced?

2018 Signup and view all the answers

What does a business typically receive after a factor collects payments from customers?

The balance of the invoices minus the factor's service fee. Signup and view all the answers

What is the purpose of the Malaysia Co-Investment Fund?

To improve financing access for SMEs and micro enterprises Signup and view all the answers

Which of the following statements about invoice factoring is true?

It manages the sales ledger to collect owed money. Signup and view all the answers

How much has been allocated for social enterprises under MyCIF?

RM10 million Signup and view all the answers

Which factor is least likely to be considered when a factor assesses a business for factoring services?

Owner's personal credit score Signup and view all the answers

What is one key benefit of invoice financing for SMEs?

It provides immediate capital based on unpaid invoices. Signup and view all the answers

What is a primary benefit of P2P lending for lenders in terms of investment?

Access to a growing asset class Signup and view all the answers

How do P2P platforms enhance transparency for lenders?

By providing detailed borrower information Signup and view all the answers

What primarily influences the likelihood of borrower default in P2P lending?

Borrower creditworthiness and financial history Signup and view all the answers

What is a characteristic of the loans typically offered on P2P platforms?

They can range from personal to business loans Signup and view all the answers

What is one of the risks associated with P2P lending?

Inability of borrowers to repay loans Signup and view all the answers

What can increase default rates in P2P lending?

Economic downturns Signup and view all the answers

What allows lenders to minimize risk in P2P lending?

Funding small portions of multiple loans Signup and view all the answers

Which type of loan generally carries a higher default rate in P2P lending?

Personal loans Signup and view all the answers

What is a primary advantage of crowdfunding compared to traditional loans?

Less formal and flexible Signup and view all the answers

For which type of projects is crowdfunding particularly ideal?

Startups, creative projects, and innovative products Signup and view all the answers

What was the initial funding goal set by the Pebble Smartwatch project on Kickstarter?

$100,000 Signup and view all the answers

How did crowdfunding benefit Pebble Smartwatch's campaign?

Allowed creators to gauge consumer interest Signup and view all the answers

Which of the following statements is true about equity crowdfunding?

It allows investors to obtain ownership in a startup Signup and view all the answers

Which crowdfunding platform is primarily focused on creative projects like technology, films, and art?

Kickstarter Signup and view all the answers

What impact did Pebble’s campaign have on the smartwatch industry?

It influenced the broader smartwatch market Signup and view all the answers

What aspect of crowdfunding provides more flexibility compared to bank loans?

Promises of rewards or products to backers Signup and view all the answers

Study Notes

Digital Financing

Digital financing delivers financial services through digital channels
Its goal is enhanced accessibility, convenience, and affordability
PayPal is an example, initially a digital payment platform, now a global financial solution
Peer-to-peer (P2P) lending is a significant innovation
Large sums of money have flowed into P2P lending over the past decade
Data analytics improve credit scoring and eligibility for lending

Evolution of Financing

Pawnbrokers were early financial lenders using collateral to secure loans
In the Middle Ages, Christians were prohibited from charging interest, while Jews could, paving the way for lending practices
The word "bank" originated from the Italian word "banca," referring to benches where money lenders sat. A broken bench, "banca rupta," could lead to "bankrupt."
The Rothschild family built an 18th-century international banking network, becoming incredibly wealthy.
Building Societies emerged in 18th-century UK taverns, pooling funds for housing. Ketley's Building Society was a notable early example (1775).
The Philadelphia Savings Fund Society was formed in the early 1800s to provide savings and loans
The Federal Home Loan Bank System, created in 1932, established a framework for U.S. residential mortgage lending.
The Diners Club Card (1950), invented by Frank McNamara, addressed the need to pay at multiple establishments without carrying a wallet.
BankAmericard (now Visa) and American Express followed shortly after, in 1958.
The MasterChargecard (later MasterCard), emerged in 1967.
FICO credit scores were adopted in 1959 to assess creditworthiness

Peer-to-Peer (P2P) Financing

P2P financing is direct lending between individuals, facilitated by online platforms, without intermediaries
The concept originated in computer networking
P2P financing addresses the lack of access to financial services and aims for financial inclusion
It pairs those seeking funds at lower interest rates with investors desiring above-average returns
P2P platforms allow capital to be channeled effectively, efficiently, and transparently, at a lower rate than traditional banks
Effective credit scoring is crucial to manage risk in P2P financing

Financing Appeal of P2P

Compared to standard savings accounts, P2P financing potentially offers higher profit potential for investors—a higher return on investment.
P2P financing in the financial community is generally viewed as having better social value than traditional banking systems.
While P2P financing offers more potential profits, it does involve a higher risk factor than traditional savings

Introduction to Peer-to-Peer (P2P) Financing

Zopa (UK) and Prosper (US) launched as the first P2P platforms in 2005
Borrowers apply, and platforms assess risk levels to determine interest rates
Loans are funded by private investors
The process generally offers better rates for both borrowers and investors

Key Metrics and Growth of P2P

Prosper had 2 million members and 6billioninloansin2016,exceeding6 billion in loans in 2016, exceeding 6billioninloansin2016,exceeding21 billion in 2023
Zopa had £1.4 billion in loans and 114,000 members in 2016
Zopa's customer base surpassed 1 million in 2023
Zopa's total loan balance reached £2.7 billion in 2023
P2P lending has shown rapid growth, with expected continued expansion

Other Key Players of P2P Platforms

Lending Club was founded in 2006 and raised $10.26 million
It became a P2P lending company in 2007, completing a major IPO (900million)in2015andcollaboratingtoprovidefundstosmallbusinessesinCalifornia(900 million) in 2015 and collaborating to provide funds to small businesses in California (900million)in2015andcollaboratingtoprovidefundstosmallbusinessesinCalifornia(10 million) in 2016
RateSetter, established in London in 2010, boasts at least 33,000 active lenders with well over $2.7 billion in assets, along with a default rate of 0.71%.
Lufax has a Shanghai headquarters and is known as the Shanghai Lujiazui International Financial Asset Exchange Co. It was founded in 2011, raising almost $500 million in 2015.
It is owned 49% by Ping An, China's largest insurer, with a CEO, Gregg Gibb. Lufax has partnerships with Saxo Bank and etoro.
LendingRobot is a loan comparison engine that applies algorithms to help lenders find the most profitable loans.
Capsphere is Malaysia's first P2P asset-based financing platform, registered with Securities Commission Malaysia

P2P Financing in Malaysia

P2P enables Malaysian businesses to borrow capital from investors through platforms registered with the Malaysian Securities Commission (SC)
The P2P Framework was launched in May 2016
As of December 2022, about RM3.87 billion in P2P financing had been raised
More than half (49%) of the investors were aged below 35, with 89% of investments coming from retail investors.
In 2022, about RM140.38 million was raised by 65 issuers

Eligibility Criteria for P2P Platform Providers

Anyone seeking to create a P2P financing platform must register with the Malaysian Securities Commission (SC) as a P2P operator through the Recognised Markets (or RMO) guidelines.
All P2P operators must have a minimum paid-up capital of RM5 million to operate in the Malaysian market.
P2P operators need to adhere to comprehensive criteria, including risk-scoring system efficiency, a robust risk assessment process, and compliance with all relevant guidelines and regulations.

Campaign Sizes

70% of issuers raise less than RM50,000
26% raise between RM50,000 and RM200,000
4% of lenders seek more than RM200,000

Types of Investors

Non-technology issuers make up 98% of all issuers
Technology issuers make up 2% of all issuers

Who Can Raise Funds Through P2P?

Locally incorporated or registered entities are permitted
Sole proprietors
Partnerships
Limited-liability partnerships
Private companies
Unlisted public companies
All others are prohibited, for example, investment funds or publicly traded companies

Who Can Invest in ECF

Retail investors: Max RM5000 per company, with a 12-month limit of RM50,000 in investment across all companies.
Angel investors: Max RM500,000 in 12 months
Sophisticated Investors: No restrictions

Eligibility Criteria for ECF Platform Providers

Applicants must be a legally recognized corporate body.
Must meet criteria within the Recognised Market Operator (RMO) guidelines
Due diligence on prospective issuers is required
Platforms must ensure investors have access to comprehensive, verifiable information
Platforms must ensure investor protection by ensuring that funding and investment limits aren't breached by issuers
Issuers are prohibited from performing activities such as mergers or acquisitions to protect investors

Benefits of P2P for Borrowers

P2P provides easier access to funds, often with less stringent credit requirements than traditional banks.
Borrowers can apply online with a simplified application process, reducing paperwork and time.
P2P platforms typically offer lower interest rates than traditional banks and credit cards
Borrowers can choose various loan terms and repayment options
Quick disbursement of funds is often a feature

Benefits of P2P for Lenders

Possible higher returns on investment than traditional savings accounts
Offers risk-adjusted returns, giving investors options to balance risk with potential rewards
Diversification options allow investors to spread funds across multiple loans, reducing the impact of any single borrower default.
P2P platforms are transparent and provide detailed information on borrowers

Credit Risk in P2P Lending

Defaults occur when borrowers are unable to repay their loans, resulting in losses for lenders
P2P lending is riskier for lenders than traditional banks because of the absence of collateral and government protections.
Default rates vary based on different factors, including loan type, borrower creditworthiness, and platform practices. A higher risk loan potentially has higher default rates from 5-10% or more
Variables that affect creditworthiness include financial history, credit scores, economic conditions of borrowers, and the type of loan

Mitigation Strategies in P2P Lending

Risk grading systems categorize loans from lowest (A) to highest (E) risk.
Investors can manage their risk by diversifying their portfolio across loans in the different categories.
Encouraging investors to diversify their investments helps spread risk

Diversification in P2P Lending

P2P platforms encourage investors to spread their funds across various loans
This diversification approach helps to reduce the impact of borrower default on overall portfolio returns

Technological Solutions in P2P Lending

P2P platforms employ algorithms and data analytics to accurately evaluate borrower profiles
Al-driven models, such as those used by Upstart, incorporate traditional credit data with additional insight like education and employment information
Some platforms have established provision funds to manage potential losses resulting from borrower defaults or account for higher-risk loans
Examples include RateSetter in the UK offering a provision fund for such cases which provides peace of mind for lenders

Platform Risk

Reliance on platform stability is a key concern in peer-to-peer lending, as lenders and borrowers depend on the operational and financial stability of the platform they utilize–a potentially significant risk unlike with traditional banks.
P2P platforms are often newer ventures, lacking the financial backing or regulatory safeguards often found in traditional banks
This increased vulnerability to market fluctuations, liquidity issues, and management challenges can place investment risk on lenders if a platform becomes insolvent or pauses repayments to investors.
Liquidity issues, weak internal controls, inadequate compliance with regulations, poor oversight can impact platform performance

Regulatory and Market Risks

Regulatory frameworks for P2P lending vary by region, impacting how platforms do business. Sudden changes to existing laws or new regulations can lead to challenges, costs, or outright closure
Example: Chinese authorities enforced strict regulations in response to widespread issues and fraud within the marketplace; many platforms collapsed as a result
Market risk relates to economic fluctuations (interest rates, unemployment) affecting borrowers and their ability to repay loans
Vulnerability during recessions (economically difficult time periods) often shows a rise in default rates, disproportionately impacting lenders

Digital Lending for Students

A specialized lending category often outside the norms of other consumer lending, student loans are treated as a unique market
Countries with robust support systems frequently subsidize such loans to make funding accessible
However, large sums of student loan debt are common (for example, in the U.S., greater than $1.5 trillion as of 2018) and may not be paid off
Digital lending platforms facilitate online lending to students and are often more accessible than traditional options

Alternative Financing

Methods outside of traditional banking to provide capital, particularly beneficial for small and medium-sized enterprises (SMEs) who might not qualify for classic bank lending
Asset-based lending uses existing assets (inventory, accounts receivable, or equipment) as collateral for loans
Invoice financing enables companies to generate funds by utilizing future invoice payments
Revenue-based financing provides funding in exchange for a portion of the business's future revenue

Invoice Financing

Provides funds for unpaid invoices via factoring, trading, or discounting—Essentially, a 3rd party (factor) preemptively pays the seller a percentage of the value of an invoice awaiting customer payment, receiving payment from the customer directly
Allows businesses to access short-term operating capital
Factors often assess a business’ creditworthiness and the customer’s payment history before granting invoice financing

Asset-Based Lending

Loans secured by assets such as inventory, accounts receivable, or equipment
Offers an advantage as it enables businesses to leverage existing assets, without dilution of ownership.

Revenue-Based Financing

Businesses receive funds in exchange for a percentage of future revenue that is then scaled according to business revenue

Blockchain in Alternative Financing

Blockchain technology enhances transparency and the integrity and security of transactions, often making digital transactions more secure by mitigating fraud
Loan origination processes are often more efficient and faster, in part because of the transparency and security aspects

Embedded Finance

Financial services incorporated directly within non-financial platforms
Simplifies funding processes by eliminating the need for separate applications or outside funding sources

Pros of Alternative Financing for SMEs

Faster access to capital
Flexible terms tailored to specific business needs—often quick approval and turnaround times
Examples include using a third-party service to manage collection practices for quick cash flow

Challenges in Alternative Financing

Higher fees or interest than traditional bank loans
Risk of asset seizure in case of default
Impacts on customer relations by requiring contact with a 3rd party financing company

Crowdfunding

Enables raising small amounts of money from many people, typically on online platforms, by individuals, startups, or companies for various initiatives
Donation-based crowdfunding often involves charitable causes without expectation of repayment.
Reward-based crowdfunding offers products or services in exchange for financial contributions.
Equity crowdfunding offers financial backers ownership in a company or project.
Debt crowdfunding enables backers to lend money for return in interest payments and repayment

Case Study: Oculus Rift

Oculus Rift was a virtual reality headset that launched and succeeded via a Kickstarter crowdfunding campaign
The company sought funding to create a VR technology project—a smartwatch
Kickstarter funding surpassed the initial goal, and its success attracted attention and acquisition by Facebook for over $2 billion

Comparison to Other Funding Options

Crowdfunding is generally less formal than bank-based loans and often doesn't require strict credit checks or collateral. It is less structured and offers flexibility in the terms for the business owners.
Funding goal flexibility and a more flexible timeline are key features of crowdfunding. This is often not the case with traditional bank-based loans, which typically have set repayment schedules.
Crowdfunding is an excellent option for startups, creative projects, and innovative products because it allows them to test the market without taking on debt
Crowdfunding can serve as a form of market validation because of the interest shown in an idea, product, or concept

Popular Crowdfunding Platforms

Kickstarter
Indiegogo
GoFundMe

Equity Crowdfunding (ECF) in Malaysia

A novel form of alternative fundraising designed for small businesses to raise capital from the public
Online platforms registered with the Malaysian Securities Commission (SC) serve as a key component
ECF enables small businesses to offer equity to investors who invest in the venture being proposed
The SC launched the secondary trading framework in 2020—which allows investors participating in crowdfunding to exit their investment
Malaysian ECF platforms have generally been experiencing impressive growth starting in 2016, along with increased call for capital market systems to adopt more technology- and investor-friendly methods

Limits on Funds Raised from ECF Platform

Malaysian sole proprietors, partnerships, corporations, and certain forms of limited-liability partnerships are eligible to receive funds through the ECF platform.
Issuers are limited to a maximum of RM3,000,000 within a 12-month period
Issuers are limited to RM20 million in total funding from all crowdfunding campaigns

Conclusion

Digital financing continues to redefine the financial landscape by introducing innovative solutions for businesses and consumers.
The digital alternative creates more accessible, transparent, and diverse funding options

End of Topic 3

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Explore the key milestones in the evolution of credit and lending practices in the United States. This quiz covers significant innovations and foundational systems that shaped mortgage lending, credit cards, and peer-to-peer financing. Test your knowledge on important dates and concepts that emerged through these financial transformations.