Peer-to-peer lending (P2P) is often misunderstood by media commentators, traditional investors and the wider financial services market. Since starting Orca we’ve heard a number of common push-backs to the P2P market which we’re eager to set straight.
1. P2P is the last and only choice for risky borrowers
This is categorically not true. Borrowers typically use P2P platforms due to their superior user experience, particularly the speed at which they reach lending decisions. A Centre of Economics and Business report commissioned by Funding Circle reported that 72% of their borrowers found the experience of obtaining a loan to be faster than other providers they’d considered. This helps to explain why 77% of borrowers initially shopped around for finance, but 94% would come back to Funding Circle first in future.
Research conducted by Orca found that traditional lenders have reduced their lending to SMEs. The regulatory costs for a bank to lend £50,000 is the same as that of a £3 million loan. Traditional lenders are not lending to this group because it is no longer commercially viable, not because of the underlying risk profile of the borrower.
2. Peer-to-peer lending is a new fad
Zopa created the first P2P platform in 2005. It wasn’t until post-recession conditions in 2010 when RateSetter and Funding Circle joined the market that the sector began to pick up pace. We now have sufficient data and an industry track record to make informed investment decisions. P2P, as a sector, is coming of age.
The history of P2P lending has been short in comparison to the concept of lending more generally. Early loan contracts, including the concept of interest and use of security can be traced back to pawnbrokers operating in Ancient Greece. The innovation that P2P platforms have delivered lies in it use of technology, not the underling concept of lending. By bringing lending online, investors can benefit from an efficient process with no intermediary, whilst borrowers receive a quick credit decision. A long ‘no’ is incredibly frustrating for borrowers.
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3. Peer-to-peer lending is the same as equity crowdfunding
Emerging at roughly the same time as equity crowdfunding and with funds initially sourced entirely from retail investors, or ‘the crowd’, P2P has often been considered to be “crowdfunding”. Currently, the only body referring to P2P as crowdfunding is the FCA who continue to refer to the asset class as ‘Loan-based Crowdfunding’. This is terminology that the P2P industry is steering away from.
Equity crowdfunding and peer-to-peer lending are fundamentally different. Equity crowdfunding involves people investing in early stage companies in exchange for equity. The businesses raising finance are often very early stage companies looking to raise finance to kickstart their venture. Successful investors on equity crowdfunding platforms such as Seedrs or Crowdcube can reap significant financial gain, however, the risks are high.
In comparison, peer-to-peer lending involves established businesses and credit worthy individuals borrowing funds directly from lenders. In return, interest payments provide a steady stream of income to investors.
The UK equity crowdfunding market has raised £480 million1 cumulatively across 6 platforms since inception while the UK P2P market has lent £9.94 billion2 cumulatively, highlighting the difference in scale between the two asset classes.
4. Only millennials invest in P2P
It’s a common misconception that P2P is reserved for the millennial generation. The assumption that technologically advanced investment solutions such as P2P and robo-advice are dominated by the ‘tech savvy generation’ is incorrect. Millennials alone cannot be expected to sustain growth in P2P lending due to the group’s broad lack of affluence.
In fact, evidence by Nesta shows that over 55% of investors are 55 years old and over, with only 12% of investors under 30.
While it is quick and simple to invest online, this is not the primary reason retail investors are attracted to the asset class. The stable, risk-adjusted returns first attracted enthusiastic retail investors before spreading more mainstream.
5. An interest rate rise will kill the P2P industry
If interest rates rose to pre-2008 conditions where savers could yield 5% from their Cash ISA, it’s likely that the P2P market would be impacted to some degree. Media commentator Damien Fahy of MoneytotheMasses predicts that interest rates will rise to 0.5% in 2018, which is still a long way off significantly impacting the P2P sector.
If interest rates were to rise, the cost of borrowing and rate of returns to lenders would follow suit. In theory, the returns generated by the P2P sector should rise in tandem beyond the Cash ISA rates. It’s the spread between the investor rate and the borrower rate which is important, not the Bank of England base rate.
6. P2P will suffer during an economic downturn
Zopa did endure the 2007/2008 economic crisis and default rates did rise from 0.18% in 2006 to 5.10% in 2008, however, Zopa lenders still earned returns of 5.49% which were down from 7.71% in the year previous.
If unemployment rates rose, the ability for individuals to repay their loans would be affected, similarly, if business insolvency rates rose SME defaults would also rise. The question is how big would the impact be and ultimately are lenders at risk of losing money? Landbay commissioned MIAC Acadametrics (MIAC), an independent asset valuation service provider, to model how the P2P provider would perform in poor economic conditions. The results found that Landbay’s expected loss rate would be 0.03% in normal economic conditions and 0.48% in poor economic conditions. Their estimates found that the returns earned by investors would fall by 0.48%, but critically investors would not have lost money. Landbay’s results may be encouraging, however, this may not be representative of the overall market and investors should understand that their capital is at risk, particularly during an economic downturn.
P2P agreements do not sit on a stock exchange and, as such, are not affected by large swings in traditional markets. In simple terms, P2P has a low degree of correlation and it’s predicted that P2P assets will perform better than traditional assets that are listed on an exchange during an economic downturn.
Peer-to-peer lending is fundamentally a different asset class to equities or bonds, as such, investors need to fully understand the risks before taking the plunge. The fundamentals of P2P are very strong and investors who take the time to learn about this asset class can benefit from stable, risk-adjusted returns.
- Altfi Data 27/6/2017 (http://www.altfidata.com/marketdata/
- Orca Industry Statistics 27/6/2017 (https://www.orcamoney.com/industry)