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There is a small manufacturing company in the northwest of England that is looking for £150,000 of working capital. It is traditionally the kind of need that might have been met by a bank loan. But, in the post-crisis world of bank belt-tightening, it is now the bread-and-butter of upstart peer-to-peer (P2P) lenders.
Within the past four days, Funding Circle, a P2P business finance specialist, has found 61 per cent of the money that the company was seeking – by offering savers like you and me as much as 15 per cent interest if we stump up our cash.
The appeal of this solution is obvious. For anyone with money to invest, 15 per cent outstrips the returns available on virtually any asset class. And, for any borrowing company spurned by the banks, this is a valuable source of funds.
It is hardly surprising, then, that the industry is growing at breakneck speed. In the UK, P2P has grown from nothing in 2007 to lending nearly £380m at the last count. There are other hotspots – most obviously in the US – where the two biggest P2P operators have together lent more than $1.7bn over five or six years; but also in less developed financial markets, such as China and eastern Europe. Even the establishment is taking notice. Lending Club, the leading US operator, now has a beefy board including the likes of John Mack, former head of Morgan Stanley, and Larry Summers, the former US Treasury secretary.
In the UK, meanwhile, the local arm of Spain’s Santander is preparing to team up with Funding Circle to help finance SME loans – in an echo of similar link-ups in the US. At the same time, Morgan Stanley has given its wealth management clients access to investments in Lending Club.
P2P has a long way to go. The industry lends a few billion dollars, which is microscopic in the global scheme of things. Even after shrinkage, there are 28 banks with assets of more than $1tn each.
Nevertheless, the excitement surrounding P2P is palpable, prompting some existential questions. Could this quick, dynamic, empowering, fast-growing form of lending change the face of finance for ever? Could P2P do to banks what Amazon has done to Walmart, and what Twitter is doing to media brands?
At the risk of sounding like a Luddite, it shouldn’t. And this is why.
First, the interest rates on offer to investors in this lightly regulated industry probably look too good to be true because they are. A 15 per cent interest rate can only mean you are in grave danger of losing your money altogether. Historic P2P loan default rates look flattering because they only go back a few years.
Second, details of the crucial credit checking process are unclear in many cases. Although some companies may have robust systems in place, others boast of being able to approve a loan in minutes with only a few pieces of information. That cannot be safe for investors.
Third, the crowd-sourcing principle of P2P reduces the intermediary company to a hands-off role that is at odds with one of the key lessons of the financial crisis: anyone who has no “skin in the game” when lending has no explicit interest in making sure the loan is a decent one.
Most worrying of all, perhaps, is that in the UK at least, P2P lending has elicited explicit government support, with the Department for Innovation Business and Skills promising to provide 20 per cent of the money that many loan applicants are seeking, under its Business Finance Partnership scheme. That will be seen as a stamp of approval, despite the carefully worded proviso that the scheme “does not provide an endorsement, recommendation or any warranty”.
For policy makers, there are clear attractions: they are promoting competition while also dealing, albeit in a rather fringe way, with the vexed question of lenders deemed “too big to fail”. If lending risk is not the responsibility of institutions such as Lending Club and Funding Circle, but the preserve of the individual investors, you can skirt the traditional problem of bank failure.
The logical conclusion would be for all banks simply to become peer-to-peer intermediaries. If banks’ depositors and bond investors agreed to take on all the lending risk on their balance sheets, the banks’ regulatory capital requirements would tumble and systemic risk would be a thing of the past.
The only snag is that most depositors wouldn’t be prepared to take that risk and most regulators and politicians wouldn’t want the populace exposed in that way. Banks might have done themselves and the world a lot of damage in recent years, but they are still better judges of lending risk than the average investor.
Patrick Jenkins is the Financial Times’s Banking Editor
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