IT’S NOT surprising that peer-to-peer lending is becoming so popular. After years of low interest rates and scandals, there is a feeling that financial services should get back to basics. And after all the upheaval in banking, there is a desire to look at new ways of lending – preferably ones that pay a decent rate of return.
Lending money directly to companies or individuals is what banks have always done, of course, but peer-to-peer lending cuts out much of the bureaucracy and paperwork needed to do it, making it more efficient and simple. It also allows lenders to know the type of person borrowing their money, and what for.
Furthermore, peer-to-peer lending continues to dominate the growing alternative finance market. Research out today by Nesta and the University of Cambridge shows that, of the £1.74bn set to be raised in the alternative finance market by the end of this year, the vast majority will be lent via peer-to-peer platforms. Once customers can use their Isa allowance to save with peer-to-peer, as seems likely, volumes will rise dramatically. Nesta estimates that the whole alternatives market could double in size to £4.4bn by December 2015.
But for this to happen, we need to recognise a simple truth about peer-to-peer lending. We are operating in a sector that carries significant risk. For a start, banks, building societies and other financial institutions have Financial Services Compensation Scheme cover, meaning that up to £85,000 of a saver’s money, per firm, is protected should that institution go bust. Peer-to-peer is not covered by the scheme.
We shouldn’t shy away from this fact, however. There is risk attached to every transaction, and the greater the risk, the higher the return. But we need to explain as an industry that we mitigate risk in new ways that may be unfamiliar to lenders and borrowers.
At Lending Works, for example, we have insured against borrower default. Savers can lend their money with us, knowing that their savings are safe – even if there was a major market downturn in which borrowers lose jobs, loans can’t be paid, and our reserve funds are depleted.
Innovation can be difficult because people are naturally wary of new ways of doing things. We know we’re the new kids on the block and recognise we need to educate customers about how we work. It is our responsibility to make peer-to-peer better, safer and more attractive, and ensure customers feel confident about saving with us.
We fully support regulation, but it is slow to be implemented and too broad in its coverage for a dynamic industry that is still finding its feet. New rules may miss the mark or, worse, could stifle innovation. Peer-to-peer lending could end up mirroring the established banking businesses we are trying to compete with. Given this, peer-to-peer platforms themselves have a duty to educate customers about the risks they are taking on, and seek to protect them as far as possible.
Peer-to-peer provides much-needed choice for customers who are prepared to accept greater risk for a greater reward – while knowing their money won’t be lost. The fact that established banks have followed our lead shows that we have the potential to shake up the financial services industry. That can only be good for consumers.
We know that financial education is the new frontier for peer-to-peer lenders. As an industry, we must deliver secure, mature platforms to help customers make their own personal finance decisions.