Peer-to-peer lending

by Rodney Hylton-Potts

A commercial peer-to-peer lender pools money from various sources (individual savers, pension funds, councils, even government) and lends it to businesses looking for a loan.

Interest rates (currently 7-10%) are often lower than those offered by traditional lenders, including banks. This is because peer-to-peer lending schemes are not ‘bricks and mortar’ businesses, but use the internet to bring lenders and borrowers together.

Fees are transparent – typically between 2-4% of the amount borrowed. Peer-to-peer lenders do not offer ‘add-on’ products such as swaps, insurance or hedging.

Time from application to funds being released is typically 12 days.

The Bank of England believes peer-to-peer lending will present a major challenge to the banks over the next decade and might even make their intermediated model of finance obsolete. At present, these companies are tiny. But so, a decade and a half ago, was Google. If eBay can solve the “lemons problem” [substandard products] in the second-hand sales market, it can be done in the market for loans.

With open access to borrower information, held centrally and virtually, there is no reason why end-savers and end-investors cannot connect directly. The banking middlemen may in time become the surplus links in the chain. Where music and publishing have led, finance could follow. An information web, linked by a common language, makes that disintermediated model of finance a more realistic possibility.

What we are seeing now is more and more businesses who are not even attempting to go to their bank in the first place; because everything they have seen in the news appears painful and their experience of their banks over the last few years has been quite negative.

The funding process is two-stage: a credit expert will vet a loan application for suitability and assign it a risk rating perhaps  from A+ to C, usually within 24 hours of the application being made. Then it is put up in the market for seven days. At present the government is funding 20% of all loans on the market, through its Business Finance Partnership, and the remaining 80% of funds comprises the lowest bids.

So if a firm wanted to borrow £100, the government would commit £20 and the remaining £80 would be borrowed from the lenders offering the lowest interest rates. The borrower pays the aggregate interest rate of the lowest (winning) bidders.