The rise of financial technology continues to show the United Kingdom’s role as an international centre for finance. Peer to Peer (P2P) lending has seen explosive growth in size and usage in the past few years, leading to speculation that it could be a threat to more traditional forms of banking.
This growth has been spurred by removing the financial institution (like banks and credit societies) that distort the interest rates that borrowers and lenders receive. In 2012 business peer-to-peer loans stood at £81m, jumping to £1,490m in 2015, while consumer peer to peer loans jumped from £167m to £909m. There is significant potential to displace traditional providers with estimates that P2P finance could equal £30bn by 2022 in the UK alone
Figure 1: UK P2p Finance
However significant questions have been raised about the long term viability of P2P lending. There are significant fears that P2P platforms are poorly operated due to examples such as the now defunct UK based Quakle whose credit rating weighted aspects like trustworthiness over credit checks resulted in an almost 100% default rate of lending on the site. Additionally, there is speculation that an economic downturn could result in significant losses to p2p lenders – many P2P lenders lack the scale and diversification to manage risk and losses like traditional institutions.
However, this issue may have been exaggerated. P2P lending is a developing platform and like Uber and Airbnb – in conjunction with a proper regulatory environment – should become a robust investment. The UK does have an effective regulatory system with a stable ‘big three’ now developing (Zopa, RateSetter and Funding Circle), who each lent over £500m in the past year. Their practices are also notably different from failed platforms with introductions of reserve funds, stronger credit checks on borrowers, increasing availability of private insurance and the availability of secondary debt markets that improve liquidity for borrowers. Consequently loan defaults are small, currently %0.8, %0.71 and %1.5 respectively and yet still maintain a high rate of return of %5, %4.56 and %7. The legitimacy and viability of these platforms is further signalled by institutional investors who now compose 32% of consumer loans and 26% of business loans.
However the Peer to Peer lending market shouldn’t be viewed simply as displacing traditional banking. There are significant tangible benefits. Small to medium enterprises often struggle to attain finance, hindering productivity in the UK economy. In 2015 alternative finance of Small-Medium enterprises rose 75% to £1.26bn, which – whilst small – shows the potential that P2P finance could have in solving UK’s productivity problem which lags its G-7 competitors by 20%. There are also productivity gains from the finance industry itself, with P2P lending having a cost base a third that of traditional banks.
The government should take proactive measures to ensure sustainable growth in the sector, as well as ending unfair government treatment towards traditional savings. Recent reforms have been promising. P2P loans can now be classified under the same rules as Investment Savings accounts, meaning more interest will now be tax free for P2P lenders, and likewise proposals to allow pension funds to use P2P lending should stimulate lending.
Room remains for more reform. Deposit insurance has been misguided by increasing risky behaviour in the banking sector and also subsidises traditional saving over P2P lenders who bear greater risk or undertake their own private insurance. Additionally, whilst there have been promising regulatory recommendations in financial planning – with the Financial Conduct Authority placing P2P lending under investment advice rules for the first time – it still excludes mandatory consideration of P2P lending to clients despite otherwise having to consider all relevant products on the market. This further inhibits the P2P sector which already struggles with awareness.
Whilst the P2P lending sector has great potential for the UK economy, for its true potential to be realised the government must allow it to grow and compete on a level playing field.