Written by Bruce Davidson on Wednesday 17 December 2014
The future of P2P lending may be bright, but not quite peer-to-peer.
From tiny beginnings 10 years ago, the P2P lending market has grown amazingly in the last two years: UK investors are expected to lend over £1bn through P2P this year. With banks out of favour and the government keen to see new funding opportunities for UK SMEs, the P2P industry is a PR dream. The Treasury’s recent consultation on allowing P2P loans within ISAs made it clear it that it is not a question of whether this is a good idea, but only of how best to make it work.
The P2P industry has bright prospects, but that growth will fundamentally change the nature of the industry. As existing financial services players fight over a new asset class and new intermediaries emerge to help people take advantage of what for many will seem a scary idea the industry will grow but become more complex than just “peer to peer”.
Originally P2P allowed people to lend small parts of a loan to other individuals, spreading risk by lending to many borrowers. With no requirement to hold capital against the borrower’s default (any loss went directly to the lender) the spread between lenders and borrowers’ interest rates was far smaller than at the banks. Both lenders and borrowers have benefited hugely.
Already this model has changed as the industry has grown. In the consumer lending space, P2P platforms like Zopa and RateSetter operate more like banks; setting rates for borrowers and lenders and operating provision funds to protect lenders from defaults. Although this has increased P2P interest rate spreads, the absence of any maturity transformation (a lender cannot demand early repayment of a loan, only try to sell it on a secondary market) means that both lenders and borrowers still get a better deal than at the banks (whose cost of capital has soared in recent years).
The original P2P model still lives on at SME lending platforms like Funding Circle and Assets Capital. However the complexity of examining SME financial statements to assess risk means this will always be a minority sport. Expect these loans to become intermediated, either by funds or investment trusts setup to target this asset class, or new intermediaries offering customers discretionary management of loans across many P2P platforms. Expect technology to mine “big data” about companies to evaluate and manage risk to play a key role.
These new layers of intermediation will cost consumers, but I expect some of that to be offset by lower fees from the P2P platforms, who will increasingly find themselves like modern fund managers; dealing with a few big intermediaries rather than tens of thousands of individuals. Meanwhile the costs of supporting an entirely new asset class with different settlement and trading methods will probably prevent the existing wrap platforms entering the space, preferring to offer exposure via funds.
These changes will allow P2P lending to scale and to take advantage of the new money the reassuring familiarity of the ISA “brand” will doubtless bring. Some may mourn the loss of the original directness of P2P and worry it will become just like the banks, but the banks have reason to fear the increasing use of P2P intermediaries. Intermediaries can manage more money than amateur “peers” ever could, providing P2P with scale on the deposits side. On the lending side, nimble, technology-driven underwriting by P2P platforms and intermediaries makes banks’ lending processes look slow and unattractive to borrowers. Banks will need more than an improvement in their PR to face this challenge.