A man recently slated peer-to-peer lending as a danger that will incur ‘big losses’ due to poor quality underwriting, and will ‘make the worst bankers look like geniuses.’ This man was the former Chairman of the now abolished Financial Services Authority, Lord Adair Turner; biased much?
P2P lending will make the worst bankers look like geniuses
Lord Adair (picture at header), although flippant and impaired in his views due to his evident lack of understanding of the industry, raises valid points. How creditworthy are the loans made? How can peer-to-peer lenders afford to pay the rates they do? How long until the banks are back in the driving seat?
Peer-to-Peer lending has now grown into an established industry; it could be said that it is banking without the bank. If you’re looking to increase your savings and bank without a bank read on and assess if P2P lending is for you.
The difference between peer-to-peer lending and banking
The products offered by banks and peer-to-peer lending platforms are pretty much the same; thus the title, ‘Banking without Banks’. Banks give you personal and business loans, so do peer-to-peer lending platforms. You can invest money in a bank’s saving account and earn interest, same goes with a peer-to-lending platform. So where exactly is the difference?
Two main differences:
- P2P investments offer the best interest rates on the market. It’s a risk/reward game, but if you compare savings rates P2P lending comes out on top.
- Banks accumulate funds from the public and invest some of their own and then issue loans. What peer-to-peer lenders do is they match people looking for loans to people who are looking to invest and earn higher interest rates.
The simplest method by which banks earn is by keeping the difference between interest paid to investors and interest received from loans. Peer-to-peer platforms also do this. The difference here is that peer-to-peer platforms are usually very transparent about their fees, unlike banks.
The same can’t be said for all UK peer-to-peer lenders. Some platforms don’t issue their APR for loan repayments, which means you can’t figure out what sort of cut they’re getting between the loan APR and the investor’s interest rate. In some cases, it can be over 10%. The peer-to-peer lender profits, as do you the investor, and the borrower gets their loan…but are P2P platforms treading thin ice by not being as transparent as they could?
Peer-to-Peer Lending VS Banks
So let us come to the most important part of the discussion: who wins, at the end of the day, banks or peer-to-peer lending? Which is the best place to invest money for you? While peer-to-peer lending may have brought about an innovation in the lending industry and earned the title of ‘Banking without Banks’ victory is still far.
For any business to succeed, it has to invoke a solid level of trust among its customers. Whether you love them or hate them, banks have been around for hundreds of years and they are perceived to be a permanent feature of the economy. In short, people trust banks to be “there” no matter what. And at the end of the day, we all will continue to hold bank accounts; bank accounts are the dominant form of account for receiving and paying out funds, but they don’t offer the best savings account interest rates in our view.
Peer-to-peer lending platforms are quite recent and have yet to prove themselves. Right now the market is in the “correction” phase. This means that some not-so-successful platforms will be pushed out or taken over; consolidation is a certainty. The banking industry on the other hand has matured and there are banks which have proven time and time again that they shall survive.
The trust in banks is shown by the fact that still 88% percent of all small business loans (excluding real estate) in the UK are provided by banks, the remainder from peer-to-peer lending. And if we were to account for real estate loans too, the percentage for banks increases to 97%.
(Based on BBA Data 2012–2014)
Do not let the above graph mislead you, however. Yes, P2P lenders are lending more to Small Businesses year-on-year, but P2P SME lending equates to a tiny fraction of yearly SME loans in the UK when you include the Bank of England:
- P2P as a % of SME New Loans 2012:- 0.3%
- P2P as a % of SME New Loans 2013:- 0.9%
- P2P as a % of SME New Loans 2014:- 3.3%
Also, the fear of fraud is still very much a consideration from peer-to-investors when engaging in marketplace lending. While the UK is yet to see a high profile case of fraud, it is inventible that as the industry grows we will see some platforms who will find a way to bend the rules. An example here would be the Swedish platform, Trustbuddy. Its operations were suspended due to suspicion of misconduct, including misuse of client money in 2015.
Fading boundaries
Recent developments have shown that it is not as simple as banks vs peer-to-peer lending. Banks may be slow and archaic but they do eventually catch up, adapt and prosper.
The launch of peer-to-peer lending was a rude shock to the banks. Its success and popularity comes as an even greater shock. But banks are going with the age old saying, if you can’t beat them, join them. What will this do to the industry? Sure, you are looking at one of the best alternative investments, with some of the best saving rates, but are you actually investing in “marketplace lending” rather than the social phenomenon of “peer” to “peer” lending? We’d say, yes.
In 2015 almost 45% of UK’s peer-to-peer lending platforms indicated having some level of institutional funding. There’s your proof.
Conclusion
Peer-to-peer lending industry has enjoyed immense success so far. It has been a joy for many. However it is no substitute for banks when security and risk come into play. At least not yet.
