David Battersby investigates the increasing popularity of Peer to Peer lending.
As banks are less able to lend following the financial crisis, due to a regulatory requirement to hold more reserves in case things go wrong again and subsequent tighter in-house policies, alternative forms of lending have grown to fill the gap.
This has ranged from payday lenders with potentially high interest rates for fixed short term loans, to Credit Unions with whom you have to be an existing member or Peer to Peer (P2P) lending. P2P is where borrowers and lenders are matched together via web based platforms such as Funding Circle or ZOPA, at rates that are competitive with traditional banking organisations. Such P2P lending platforms use financial technology to determine a borrower’s creditworthiness.
Incumbent banks operate with large fixed costs including staff, branch infrastructure and administration, impacting their rates of interest. The concept of P2P lending has lent itself to a broad range of products from consumer debt, loans to small and medium sized enterprises and corporate invoice receivables.
Loans can be provided by individuals through a platform or by investment companies who raise funds to provide capital to be lent in the same way. In this low interest rate environment, it has proven to be an attractive source of finance with higher yields compared to putting money on deposit with the bank. However, the yield is not guaranteed and funds lent in this way are not covered by the Financial Services Investor Compensation Scheme. To counter this, some platforms have reserve funds to partially offset this risk. This type of lending is not a panacea for those with a poor credit rating as only one in five loans applied for are accepted.
For those who wish to lend in this way can buy shares in an investment company that provides the lending capital, listed on the London Stock Exchange. Such funds have proved very popular, raising money on multiple occasions and, consequently, some trade at a premium to their net asset value as investors accept the additional risk and pay up for yield as apposed to such risk free assets as Gilts and money on deposit.
In order to value these funds, it is important to evaluate how much capital one has to forgo to achieve the yield expectation. This reveals that the stock market offers the opportunity to not only invest across various asset classes, but to enable one to reduce risk through traded pooled vehicles in specific asset types.
The financial crisis popularised P2P lending, making it a destructive force in the lending market. This has risen exponentially to the point that it is now a credible alternative to Gilts that offer just 0.6% and with Retail Price Inflation of 1.9% provide negative real rate of return. Initially disruptive P2P lending appears to be here to stay.