Will peer-to-peer lending change the personal loans market beyond recognition? Or will increasing regulation and overheads erode its differentiators? Traditional savings products are not attractive at the moment, with typical interest rates for one-year cash ISAs at less than 2%. At the same time, peer-to-peer lenders such as RateSetter and Zopa suggest their lenders can receive long-term returns of 4% or higher. So it is no surprise that the UK peer-to-peer lending market is growing exponentially, with £ 221m of loans in 2012, and an estimated £ 522m of loans in 2013.

Remembering that there is no such thing as a free lunch, you might expect the high returns forecast by peer-to-peer platforms to come with some strings attached. And, indeed, they do.

The first string is credit risk. In the pure peer-to-peer model, credit risk lies entirely with the lenders and the platform provider carries no credit exposure. Peer-to-peer loans are usually unsecured, so if a borrower defaults on their loan, lenders stand to lose all of the capital that they have lent to that borrower—plus any unpaid interest. To understand this credit risk, lenders need access to credit information on prospective borrowers.

The second string is the need to manage a lending account actively. To maximize returns, payments of interest and capital back to a lender must be quickly reinvested in new loans. Unlent funds earn little or no interest.

The third string is liquidity. Peer-to-peer loans are made for a fixed term, and a lender cannot unilaterally decide to withdraw their funds before a loan ends. Even if they could sell their participation in the loan to another investor, they may have to sell at a loss.

Peer-to-peer platform providers are addressing these issues. Most providers supply investors with some credit background on potential borrowers. Some providers mitigate credit risk by creating a ‘compensation fund’ that covers a proportion of losses due to defaulting borrowers. Automated reinvestment reduces the time required to manage a lending account. And an active secondary market in loan notes improves liquidity.

All of these developments make peer-to-peer platforms more attractive to lenders. But at the same time they increase platform providers' overheads. Higher overheads must be covered by higher fees.

In April 2014, responsibility for consumer credit regulation will be transferred from the UK financial services watchdog the Office of Fair Trading (OFT) to the Financial Conduct Authority (FCA). The FCA has announced that it will enhance protection for both borrowers and lenders using peer-to-peer platforms. Although it is not yet clear what form this enhanced protection will take, we can predict that additional regulation will also increase overheads.

As the P2P market becomes more regulated, platforms develop more infrastructure, and overheads rise, will lenders' returns drop? And will P2P platforms eventually become indistinguishable from small online banks? For the time being, it looks as if the system is catching up – at least until the next peer-to-peer innovator develops a model that succeeds in neutralizing these costs.

 

References

 

Peer-to-Peer: Filling the Lending Gap, Datamonitor, July 2013

High-level proposals for an FCA regime for consumer credit, FCA Consultation Paper CP13/7, March 2013

www.moneysupermarket.com

Votes: 0
E-mail me when people leave their comments –

You need to be a member of Global Risk Community to add comments!

Join Global Risk Community

Comments

  • I've been lending on P2P platforms (RS & Zopa) for almost 3 years and my experience has been positive, despite some defaults in the early days before the largest player (Zopa) introduced a blanket compensation fund. It's not for everyone - those of us who understand systemic risk may be nervous of any impending rise in interest rates - but for funds I don't need in a hurry P2P has so far delivered returns streets ahead of anything on the traditional banking market.

    I don't believe increased regulation will prove onerous, at least not for the established lenders who seem to be well-prepared for it.

  • Dear sir,

    I need running finance for our export order?what is the possibility kindly send us detail with your contact number on our id. orientals786@gmail.com skype oriental.enterprise cell +923218293646

    Khursheed Ahmed 

    Chief Executive 

This reply was deleted.

    About Us

    The GlobalRisk Community is a thriving community of risk managers and associated service providers. Our purpose is to foster business, networking and educational explorations among members. Our goal is to be the worlds premier Risk forum and contribute to better understanding of the complex world of risk.

    Business Partners

    For companies wanting to create a greater visibility for their products and services among their prospects in the Risk market: Send your business partnership request by filling in the form here!

lead