When you have a burgeoning European alternative finance market originating over 400 million EUR per month, it’s no surprise that governments are paying close attention. So, what are some of the approaches that national authorities have been taking to encourage the sector, and what is the appeal?
Why Do Governments Like P2P Lending?
Some of the benefits for a country to encourage P2P lending are clear, it:
- stimulates investment and spending within the economy,
- reduces the cost of borrowing for consumers and small businesses,
- offers higher returns on savings for investors (and potentially higher tax revenue for the government too!),
- encourages innovative fintech start-ups that bring jobs, technical skills and help to foster a local entrepreneurial ecosystem,
- enables socially-conscious lending to environmentally friendly industries and local businesses.
What Approaches Are National Authorities Taking?
Lender Tax Benefits
National tax authorities can encourage retail investment from the general public by reducing or eliminating taxes on P2P investment returns, up to a certain limit per person. It is far more enticing to invest your money if you are not expecting 30% or 40% of the returns to be paid as a tax! Tax authorities can also make it easier to write off capital losses against income to reduce tax. The UK is doing this with the first £1,000 (€1156) of interest income tax-free per person, and an additional personal tax-free investment vehicle being launched this year (IF ISAs).
Platform Founder/Shareholder Tax Benefits
Successful lending platforms often need significant investment to build the IT infrastructure, businesses processes, and marketing before they can start writing loans. By recognizing the risk that founders and early investors take through tax breaks and similar incentives it encourages new innovation. One example of this is Ireland, where P2P lending start-ups have been able to raise funding through the Employment & Investment Incentive Scheme (EIIS). This allows initial investors in the platform (rather than the loans) to claim up to 40% income tax relief up to €150,000.
Direct Investment in Loans
Governments can create a state investment body to invest directly in loans via P2P lending platforms. Aside from helping the platforms, this process will share many of the same benefits as traditional quantitative easing as it releases more money into the economy. The UK state-owned economic develop bank has already invested £85million (€98million) directly in P2P loans.
Light Regulation / Sandboxing Environments
While intelligent compliance regulation is necessary, heavy-handed and outdated regulation can weigh down on the growth of P2P lending platforms. Governments can work towards reducing unnecessary regulation or even create a ‘sandbox environment’ for start-ups. Australia has started to offer one such regulatory sandbox scheme, where alternative finance start-ups can trade for the first 6 months without a financial services license.
Unintended Consequences
As mentioned above, one incentive to encourage investment in peer-to-peer lending is to offer tax breaks for lenders. The UK’s Financial Conduct Authority is currently working with British platforms to implement a structure called an ‘IF ISA’ (Innovative Finance Individual Savings Account) which means lenders have no tax to pay on P2P investments held within the structure. This is an adaption of a well-established scheme which had been to encourage traditional bank savings, called a ‘Cash ISA’. These tax breaks have been incredibly popular, with £518billion (€598billion) currently invested in ISAs according to the UK government’s latest statistics. It is likely that as these P2P ISAs come into play over the coming months, there will be a huge increase in interest and demand from general UK retail investors.
However, if we look at the example of Cash ISAs, this development may not be as good for UK lenders as they hope. What happened in practice was that rather than passing the tax savings on fully to the investor, financial institutions reduced their interest rates. So, the huge demand brought on by the tax-free structure actually pushed down the rates of return. If I do a search on a comparison site now, the highest rate I can find for a 5-year term Cash ISA is 1.6%, whereas I can find 2% or 3% in a regular savings account. Will a similar thing happen with the £3.2bn (€3.7bn) UK peer-to-peer market and the IF ISA? If so, UK investors seeking higher gross returns may increase investments in other European countries, including the fast-growing Baltic region.
