In the UK banks are pushing back against what monetary policymakers have described as a “borrowing binge” among UK households. In fact, over the past quarter, traditional banks have tightened credit to levels not seen since the financial crisis, according to a recent survey by the Bank of England. Indeed, some 10 percent of banks have made it harder for borrowers to obtain an unsecured loan.
Meanwhile, this topic has spilled over to peer-to-peer lending, which has risen to fill the gap where traditional lenders have fallen short. RateSetter, for instance, is facing GBP 80 million worth of “struggling loans” in a sign that the growing startup is experiencing a growing pain.
Investors have poured GBP 2 billion onto the P2P lending platform that yields as much as 4.7 percent, and they will largely be shielded from any losses. That’s because RateSetter is dipping into its coffers to cover the loss.
“We did something on behalf of our lenders that was quite clearly a mistake. It is not right for them to take that hit,” exclaimed RateSetter co-founder Peter Behrens.
One of the problems for RateSetter had to do misjudging the risk associated with a loan it issued to auto finance company Vehicle Trading Group. After the company had gone into receivership, RateSetter acquired a pair of the troubled company’s subsidiaries in an attempt to recoup its losses eventually.
Meanwhile, P2P is a market segment that investors have run to in search of yield amid a low rate environment in the fixed income asset class. And for the most part peer to peer has delivered, evidenced by returns in the range of 4 percent to 6 percent, according to AltFi News.
Nonetheless, P2P remains a nascent market that even through growth continues to face certain misperceptions, which inspires questions about financial services stemming from politicians to investors, to regulators.
Reinder van Dijk, a partner at economic analysis firm Oxera, said at the last LendIt conference in Europe that the uncertainties in P2P inspire some critical and “fair” questions, such as is P2P appropriate for individual investors? How would the P2P marketplace respond in the face of deteriorating credit market conditions? And what about if a lender completely misjudged its risk and went under amid a wave of defaults – what would the fallout be for investors and financial services?
While the answers to some of these questions will unfold over time, evidence suggests there are steps that the lending marketplace can take to ensure that the future of P2P lending is secure for all participants, ranging from borrowers to investors, to the lenders. Oxera’s Van Dijk said to have well- functioning markets that attain their potential for economies of scale the industry should focus on the following four pillars:
- sustainable business models where there is a mutual incentive between consumers and the lenders as well as investors and the lenders, beginning with an assessment of credit risk;
- industry regulation must evolve and should be designed specifically for P2P lending, not broad brush in nature;
- best practices across the market, which could develop in the years to come to a result of both formal rules and self-governing. Consumer education is critical. For P2P to expand into the mainstream, everyone from borrowers to investors must have a clear understanding of what peer-to-peer lending is all about.
Meanwhile, the recent struggles at RateSetter point to at least one of these key themes, the most obvious of which being credit risk assessment and a sustainable business model. Without proper credit standards both the P2P platform and the investor are exposed to a greater level of risk than they may be able to afford, which wouldn’t bode well for either side.
Importantly, the incentives for proper credit risk assessment are there, van Dijk points out, evidenced by a lending platform’s reputation being at stake in addition to the strength of its balance sheet.
Peer to peer has evolved into an asset class of its own, providing participants a way to generate returns they might not find in more conservative investments. As for the risk/reward profile, van Dijk said P2P falls right in the center of bonds and stocks. For an emerging asset class, investors looking for somewhere to allocate their long-term savings can know the type of risk they’re inheriting.