Redefining P2P lending
The reason behind why P2P lending is gaining popularity is quite easy to see. Mark Carney (Bank of England governor) explained that, when it comes to financial institutions, “the more people see, the less they like”, and it’s not totally hard to see why people feel this way. A rate of £5m per day is the estimated loss of small businesses and branch closures are seriously decreasing SME lending. That’s why people are looking for an alternative to conventional banking.
In a strictly conceptual sense, P2P lending is what investors and borrowers are looking for. The transaction is being made through online platforms where retail investors can offer a better proposition for borrowers (who aren’t obliged to indifferent institutions who might withdraw their credit or change the terms of their agreement), and that lenders can benefit from better rates and negligible risk.
The most exciting promise is that it will democratise finance. Meaning, that the power combined by financial services can be redistributed to individual borrowers and lenders – the proverbial ‘men on the street’.
Theoretically, it’s a win-win situation but it doesn’t quite work like that in reality!
The main issue is that numerous lenders are quite willing to use institutional funding when it’s favorable to them. Like for example, Zopa, the world’s oldest P2P lending service called its latest partnership with Metro Bank as a ‘milestone’, and ‘evidence of how P2P platform have matured’. If having a bank partnership is considered as a milestone, then it seems institutional investors must be at the end of the road – particularly since 40% of its funding are not from individual lenders.
Another example is FundingCircle, a well-known successful P2P lending service. Retail investors are not the only source of the firm’s funding. As a matter of fact, it makes investments on behalf of the government’s British Business Bank, universities, local councils as well as launching its own fund.
Lastly, there is FundingKnight, another big-name P2P organisation. It was so obligated to its institutional investor GLI Finance that when its line of credit was withdrawn, it collapsed, putting at risk the savings of 900 people. In the end, GLI Finance obtained the company.
These are only a few examples of P2P lenders that are not living up to their billing. It’s an industry-wide phenomenon. Kadhim Shubber of Financial Times points out that when using Ratesetter, you don’t directly communicate with any of your borrowers. You just select one of a variety of products. It’s the same story with Zopa.
In addition, Shubber compared these companies work to that of traditional asset managers because a fee is being charged in exchange for the allocation of capital. This appears to be a more accurate description than ‘peer-to-peer lending’, even if it is less appealing to focus groups.
Just to make it clear, there is no intended criticism of these practices. In fact, it’s still entirely possible to offer another institutional investment without being a traditional bank. The problem is that the whole P2P lending industry has silently agreed on this slight definitional ambiguity, while at the same time taking great pride whenever an institutional investor gives it the slightest attention.
And the reason why they pay attention to the P2P industry is because of its great marketing. A company that’s seen as fundamentally communitarian, (meaning, a company without the bureaucracy of ancient, big-money financial services companies to hold things up and kill good ideas in their cribs) will always get the more public image than a company which basically serves as a fund management firm for investors with less money.
However, despite its great marketing, retail investors and institutional investors are not always treated on equal terms. For example, the P2PFA (The Peer-to-Peer Finance Association) has lately had to introduce a rule change that specifically prohibits companies from granting bigger organisations on ‘cherry-picking’ the best loans. Institutional investment is being used by every member of its executive body to some degree or another. With Zopa and FundingCircle, this kind of lending is totally unstopped;
Expanding Peer-To-Peer
Part of the problem comes from not yet having proper parameters despite understanding the concept of P2P funding.
Accessing the P2P FA’s website is not helpful anymore. Undertaking a debt-based financial services businesses in the UK through an electronic platform is a must for its members. In addition, they must show “high standards” of credit risk, operational risk management, and transparency.
It’s quite unclear and in the eyes of an uncharitable person, this condition is intended to give the organisations’ membership the maximum possible wiggle room. The accurate percentages of institutional loans are private and unknowable, but it’s ideally possible for these firms to lend 1% of their money via genuine P2P loans while the other 99% through retail banks.
It appears to be that P2P’s working definition is a company which loans some indefinite amount of money, on an online platform, through individual consumers. This definition should be updated or changed one way or another, and there could be three clear options.
Firstly, there must be a clarification of what is and isn’t P2P lending. In some circles, there’s a debate that no more than 50% of institutional funds a qualifying funder should have. This may be lax or prohibitive, it all depends on in your standpoint. But whatever it may be, it’s a lot more precise than “some” – though whatever the number ends up being, it may well feel unreasonable.
Next is to simply do away with the term totally, and to place it under the umbrella of “alternative finance”. By doing this, any confusion with traditional fund management would be prevented. Although it likely wouldn’t help the issue of ambiguity.
And lastly is to broaden the definition of P2P lending that includes institution-to-peer (I2P) lenders and qualifying alternative financiers. This may upset purists, but in this industry, disappointment is unavoidable for purists. A small number of companies offer the full, pure individual-borrower-to-
Among the three solutions that were presented, the last one is probably the best one. Why? It’s because, in the end, the true appeal of P2P lending is not quite the source of the money as the fact that the money is available. When a small business applies for a loan through a traditional high street bank, there’s so many administrative checklists and underwriters to do. In some cases, the application may be dismissed on false grounds or its finance may be withdrawn based on uncontrollable circumstances.
However, Institution-to-peer lenders are entirely independent of this kind of funding, as well as other alternative financiers. Convenience, accessibility, and capital, this are the three things that a P2P company needs to stand out. The ‘P2P’ part is fairly optional, as most organisations in the industry would reluctantly admit. If a financier is transparent, willing, and is able to supply the money, it won’t be an issue if the funding comes from either an institution or a retail investor.