The end of peer-to-peer lending?

By Marcus Hunt

Peer-to-peer lending is a highly innovative means of businesses acquiring capital; crowdsourcing loans from dozens of small investors is a way for both parties to secure better interest rates by cutting out the cumbersome middle-men at the banks. From humble beginnings, sites like Zopa, Ratesetter and Funding Circle have now facilitated loans of over £1 billion to small and medium-sized British businesses. However, I think that there is good reason to believe that over the medium-term the growth in peer-to-peer lending will slow and possibly begin to reverse.

Peer-to-peer lending is a child of the recession, and the economic conditions that have led it to prosper are coming to an end. During the recession, banks were highly conservative in their lending practices. But over the next few years, as the economy recovers, banks will likely become more willing to make loans to riskier small businesses. With banks more amenable to lending money, fewer small businesses will be inclined to seek out the unorthodox channel of peer-to-peer lending into which they were previously forced.

The incentives that drove small investors into peer-to-peer lending are also set to weaken. Most lenders who avail of the peer-to-peer model are not professionals looking to make millions. For instance, of the 30,000 investors on Funding Circle, the average amount lent is a little over £10,000. Such platforms encourage small investors, as the minimum chunks in which capital can be lent are as little as £10 or £20. I suspect that, like me, many peer-to-peer investors are ordinary savers who are sick of seeing their already modest sums eaten away by inflation. If they weren’t putting their capital into peer-to-peer, it would likely be languishing in current accounts rather than being invested in some other way. According to the CPI, inflation averaged 3.3% over the period between January 2008 and May 2014, peaking at nearly 5% in 2011. This means the value of currency has decreased 21.1% over the period. Pretty bitter stuff for savers; a sharp shove towards finding something other than traditional banks to put their money in. However, if inflation settles at its current low rate of 1.5% then potential small investors will be less pushed towards the peer-to-peer model.

Whilst the period of high inflation seems to be at an end, many savers are still seeing current account interest rates of 0.1%, and only 1 or 2% if they willing to tie up their money for longer. However, as Mark Carney recently commented, the Bank of England base rate will most probably rise to 2.5% over the next three years. For the first time in nearly a decade, savers will see inflation-beating levels of interest on their savings. When inflation was high and interest on bank accounts was near non-existent, the 6% average return offered on platforms like Funding Circle was a very attractive proposition.
However as these two ‘push’ factors fade, I expect that savers will be less sanguine about peer-to-peer lending. It’s true that as current account rates increase the average returns on peer-to-peer lending will likely increase as well. However, psychologically, for ordinary savers, exiting government-guaranteed bank accounts is a big deal. Risking your capital for a possible extra 3 or 4% rate of interest is a different and less attractive proposition than doing so merely in order to avoid your capital from being steadily ground down by inflation.

There’s no doubt that peer-to-peer lending is a convenient model for both businesses and small investors, and I expect that it will continue to grow in the short-term simply because more and more people are becoming aware of it. However in the medium-term it faces significant dampers. In the long-term I expect peer-to-peer to stay with us, but only really thrive in recessions, when times are tough for savers and businesses and they are forced to find alternative routes for capital.