Last week, the Financial Conduct Authority released interim feedback on their review of their crowdfunding and peer-to-peer lending rules. And it didn’t sound good.
Andrew Bailey, CEO of the Financial Conduct Authority (FCA), stated that the “fast-moving, evolving” peer-to-peer (P2P) lending industry poses “some quite big challenges in terms of transparency and fairness.”
Following this, the FCA announced that it’s looking at tightening up the P2P industry. Why? Because of the potential for certain developing practices to harm consumers.
The regulator felt that the industry was moving to a place where consumers are likely to take on more risk under the false belief that their investments were safe. Another concern is that institutional investors may also be getting preferential treatment. They bring a lot more money to the platform, giving the platforms themselves more volume on which to generate fees.
What is Peer to Peer lending?
For starters, it’s an £8.7 billion industry. However, it was invented by the British company Zopa back in 2005. At face value, the model appears quite simple. People using online platforms lend directly to other people or businesses. This cuts out the middleman, usually the bank. Investors get good rates of return, and borrowers get quick access to cash.
It sounds great, doesn’t it? But in a market that is evolving so fast, it can be difficult for consumers to compare one alternative lender model with another. At the same time, innovation creates more complex business models that expose both the consumer and the lender to greater risks.
The consumer has the ability to borrow vast sums of money that may be beyond their reach to pay back, and the lender may be carrying on business outside their original permissions.
In the race to innovate or disrupt, it’s easy to see how harmful practices can creep into an industry, mainly unintentionally.
Advantages and Disadvantages of Peer-to-Peer Lending
Peer-to-peer (P2P) lending is an innovative approach to borrowing and lending money that has gained popularity in recent years. It involves connecting individual investors with borrowers, typically through online platforms that facilitate the process. While P2P lending has some advantages, it also has some drawbacks that should be considered.
Advantages:
- Lower interest rates
- P2P lenders generally have lower overhead costs than traditional financial institutions, which can result in lower interest rates for borrowers.
- Accessibility
- P2P lending provides access to credit for individuals and businesses who may have difficulty obtaining loans from traditional lenders due to strict lending requirements.
- Diversification
- P2P lending offers investors the ability to diversify their portfolios, as they can invest in multiple loans with small amounts of money.
Disadvantages:
- Risk: P2P lending is a form of investing, which means there is always the risk of losing money. Borrowers may default on loans, and there is no guarantee of returns for investors.
- Limited regulations: P2P lending is a relatively new industry, and regulations vary by jurisdiction. As a result, there may be limited protection for investors and borrowers in the event of disputes or fraud.
- Lack of transparency: P2P lending platforms may not provide complete transparency on their loan origination process, borrower creditworthiness, or other important factors. This can make it difficult for investors to make informed decisions.
P2P lending can be a useful alternative to traditional lending options for both borrowers and investors. However, it’s important to carefully consider the advantages and disadvantages before participating.
What you need to know about peer-to-peer lending
When you use a peer-to-peer website to borrow, you’re not actually borrowing from the peer-to-peer provider. They arrange for their customers to borrow from each other, so your actual lender is one of the peer-to-peer website’s ‘savers’.
The interest you pay on the loan is the interest you receive on the money they invest, and as it’s their money, they decide on the type of borrower they would like to lend to and at what rate. As such, they’re often getting a better return than if they’d put their money in a savings account.
Let’s get back to a traditional approach where people knew each other
In a new market that is disrupting traditional finance, there is no point in advertising to consumers who are uninformed.
I strongly believe that many of the current alternative business lenders are building brands through advertising. They hope to build market valuation so that investors can exit at high earnings with absolutely no regard or understanding of the underlying business – lending!
Education should form the foundation upon which any new and disruptive industry is built. Fancy advertising and the publishing of statistics that are fundamentally flawed should not.
Instead of throwing money into glossy adverts, I believe the best foundations are built by going back to the old days of lending when your bank manager knew you. They even knew your family, your business and your friends. They would never lend to someone unless they met them and got to know them personally. That’s my approach to lending.
Ok, I accept it isn’t possible to meet every customer for a £10k loan when you are doing hundreds of them a month. But sensible and sustainable lending is about a lot more than just computer algorithms – something many of today’s new lenders either ignore or simply don’t understand.
In the true spirit of crowdfunding, I believe that it’s vital to build a community where the participants learn from each other, in addition to the education that is provided by the alternative lenders themselves. In this increasingly social era, investors can learn from each other. Lenders can also genuinely know their clients rather than having to rely on information being fed to them by platforms or computers.
Built on these pillars, I believe that the firms I advise will stand out in the alternative lending industry. The industry will tighten up over time, and I believe that leaders in this space will be those that embrace transparency, fairness, putting the customer first, and education.
For more information on financial advice, business lending, and self-development, listen to my valuable business advice on my podcast, where I interview many high-performing business leaders and entrepreneurs.
