WEEKLY COMMENT 18-06-2015
By Barry Edwards
The Transformation of Peer-to-Peer Lending
Originally the principle of peer-to-peer lending was that private individuals lent money directly to consumers and small businesses via online sites that managed the process. The main incentive was the better interest rates compared to bank deposits, government bonds or quoted bonds of large companies. In this low interest rate environment it makes perfect sense to risk small amounts spread over many loans which can pay rates from 5-15%, the higher rates are mostly for consumer loans.
Alternative finance is the term used to cover all forms of lending and equity investment which is referred to as crowd funding. The market has been growing rapidly and is now estimated to account for around £3 billion of lending and equity investment in the UK. Over the last few years some institutions have become involved providing large sums of money for these Internet sites to manage on their behalf. Their motive is the same as private individuals, to obtain a better yield than they can achieve in the financial markets.
This week Goldman Sachs announced that they are creating an Internet banking platform to lend directly to consumers and small businesses. The term they have adopted to refer to this kind of lending is ‘marketplace lending` and it is funded by their clients and other institutions in the USA. It will not be long before it arrives in the UK creating serious competition to the ‘peer-to-peer` lenders that have dominated this market up to now. The main difference between the two approaches is that ‘marketplace lending` is entirely financed by institutions which is then leveraged to increase the lending pool substantially.
Currently most ‘peer-to-peer` lenders have a minority percentage of bank and other institutional funding for their platforms and in the case of Funding Circle, the largest in the UK, the proportion is around 30%. At the moment the balance between lending by private clients and institutions is kept to around that level so that the original concept is not altered significantly. With the entry of Goldman Sachs, it is clear that the market will change and the opportunities for private clients will be restricted to certain platforms that wish to remain loyal to the original concept.
It would appear that the alternative finance market is about to transform itself from a mainly person to person or small company funding arrangement to an institutionalised format with gearing funded by the banks, institutions and securitised bonds. This will compete directly with the banks since it will provide a quicker and more efficient system without the need for a branch network and much of the expenditure that banks incur. The biggest advantage for the ‘marketplace lenders` will be that they can match long-term lending with similar funding from a wide range of sources where the banks rely on short-term deposits. This ultimately means that the risk of a sudden withdrawal of deposits for whatever reason will not affect the lending arrangements of borrowers in the bad times which did happen during the recent financial crisis in some countries.
The policy being promoted by the Bank of England and the European Central Bank encouraging securitised asset backed lending, which is struggling to take off at the moment, would be greatly enhanced by the creation of these new ‘marketplace lenders` allowing direct funding for companies when the banks withdraw from lending to small and medium sized companies (SME’s). They would be able to access central bank funds giving governments a powerful alternative source to stimulate lending when the banks are unwilling to lend.
With the big effort being made to stimulate capital markets in Europe, companies will have access to a much more diverse range of finance which should improve the potential to invest in the expansion of businesses that has been sorely lacking during the financial crisis and prior to that. Finally, providing a company can put forward a good case for investment or working capital requirements, there will be many more organisations willing to lend to and support businesses wishing to expand. This can only be good news for many SME’s that have had a rough time over the last five years and for periods of slow economic growth in the past.
During the next few years we are likely to see a big change to the way companies and consumers access finance putting great pressure on the traditional banking model. The cumbersome and uncertain process banks employ to decide who to lend to will be refined and improved to make the whole system more ‘user friendly` and mainly managed and implemented over the Internet. Providing you can tick the right the right boxes, anyone will know if they are acceptable within 24 hours and funds can be dispersed almost immediately as the money transaction systems are improving all the time.
The groundwork to prepare for expanding a business will still take the same time but the knowledge that a quick decision is available will encourage many more companies to take the time to go through this process and make the effort to grow their business. This can only help to improve the economy in general creating a positive environment for businesses and people to invest in their companies.
That’s all for this week, more observations next week.