Why Peer-to-Peer Lending Is The Future
Peer-to-peer lending has the potential to transform finance.
Already a significant part of the UK financial market, it looks set to keep on growing.
What is Peer-to-Peer Lending?
Peer-to-peer lending (P2P), also called crowd-lending, is like a matchmaking service for lenders and borrowers.
Anyone can become a lender and in the process earn more interest than they would through a conventional savings account.
Using a P2P website, you can lend as little as £10 to other people and companies, earning interest rates of 5% and above.
P2P contributed £3.2 billion of lending in the UK in 2016 (https://www.telegraph.co.uk/money/special-reports/can-still-profit-peer-to-peer- lending/), £1.23 billion of it going to small businesses (https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternative- finance/downloads/2017-12-21-ccaf-entrenching-innov.pdf).
That’s 15% of the total amount banks lent to small and mid-sized businesses in the same period, meaning that P2P contributed significantly towards the economy.
At times, P2P lending can just seem like having another bank account. But unlike a conventional bank account, there’s a risk of loss that makes it more like an investment.
So why invest in P2P?
Advantages of P2P
The main advantage of P2P lending is its interest rates. P2P lenders cut out the middlemen by not involving banks.
Operating on a leaner business model than the banks, they offer slightly lower interest rates to borrowers and significantly better rates to lenders than they would get on a savings account.
Instead of the traditional model where banks become a central pool of liquidity, to be doled out as they cautiously see fit, the money goes directly from the saver to the borrower, with the P2P business taking a cut along the way.
In return for that cut, P2P companies provide the services necessary to make such loans work. They decide which borrowers are reliable enough to safely be lent money.
They credit check them and rate them by risk, to help investors work out how to lend their money.
And if a payment doesn’t turn up on time, they’re the ones who chase it, taking that burden off the lender.
Government regulations help to support this. A chunk of the interest earned via P2P, as on any savings, is tax-free.
The personal savings allowance (PSA) means basic-rate taxpayers can earn £1000 in untaxed interest, while those on a higher tax rate get £500.
On top of this, the recently introduced “innovative finance ISA” (IFISA) gives a more efficient way of doing P2P lending.
Investors can use it to lend out up to their annual ISA allowance of £20,000, keeping that whole chunk of money tax-free.
Even after taking their cut, P2P businesses offer between 4% and 7% interest to investors.
Combined with the tax-free element, that’s a tempting offer for savers, as well as a good way for borrowers to access finance.
Risks of P2P
Like any investment, P2P lending comes with risks.
Firstly, there’s the risk that the borrower won’t pay you back.
Each site manages this risk in different ways, but the big players tend to have contingency funds with which to cover losses.
When investing in P2P, it’s worth looking at this when choosing a site. Secondly, there’s the risk that the P2P site itself might go bust.
Technically, investors are lending to borrowers through the sites, and so could still reclaim the debt, but in practice, this isn’t so easy without the site as mediator.
The Financial Services Compensation Scheme doesn’t cover these sites going bust, as it does with traditional lenders.
But FCA rules say that British P2P lenders have to keep their money separate from that of their clients, which should offer protection.
So far, there’s only been one significant collapse, that of Collateral in February 2018.
As long as the business has a wind-down plan and is following regulatory rules, then the money should end up in the right hands.
Some commentators say that P2P hasn’t been through a full economic cycle yet, with the losses that come when the economy tightens, and that these schemes may lose their advantage then.
But these businesses flourished in the aftermath of the 2008 downturn precisely because of the services they offered, making that risk seem remote.
Why Go P2P?
Since 2014, the Financial Conduct Authority has regulated P2P lending.
Clear rules are already in place for P2P sites and the FCA is even considering tightening these up, providing more security for lenders at the cost of lower competition among the sites.
Most of the major sites are also part of the P2P Finance Association, an industry body which helps to set standards and provides guidelines for how these businesses are run.
Like any investment, P2P has risks, but it offers significantly better returns than conventional savings.
As long as it’s done through regulated businesses, it’s a good bet for both lenders and borrowers.
By allowing lending at better rates than that offered by banks, P2P lending is freeing up the flow of finance in the UK. It creates greater opportunities for businesses and greater rewards for lenders. It makes investing accessible.
Given all the benefits, this is undoubtedly a model that will keep growing.
Paul Connolly
Paul Connolly has been a journalist for more than 20 years, as a reporter and editor for Argus Media, Reuters, The Times, Associated Newspapers and The Guardian. He has covered Islamic Finance for Reuters in the 1990s. Paul has since helped launch three newspapers, as well as reported from Tokyo, Los Angeles and Stockholm.
