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6th July 2017

What is P2P lending and why are banks taking advantage of it?

by Huddle Capital

Have you heard of P2P lending?

You might have noticed the term P2P lending is cropping up more frequently within the investment world. Peer-to-peer (P2P) lending or ‘social lending’ is a method of obtaining alternative investment funds through non-traditional means such as a loan application to a bank.

You might have noticed the term P2P lending is cropping up more frequently within the investment world. Peer-to-peer (P2P) lending or ‘social lending’ is a method of obtaining alternative investment funds through non-traditional means such as a loan application to a bank.

You might have noticed the term P2P lending is cropping up more frequently within the investment world. Peer-to-peer (P2P) lending or ‘social lending’ is a method of obtaining alternative investment funds through non-traditional means such as a loan application to a bank.

P2P lending allows individuals to act as investors to provide borrowers with the funds they require, receiving a return on the investment funds through means of interest on the loan.

Whilst popularity of P2P is rising, there are many investors who know little about it or feel that there is added risk without a “middleman”, or the returns seem too good to be true and are probably fraught with default risk.

Figures compiled by P2P Finance Association and ALTFI, show that returns have been around the 6% APR mark, whilst default rates have been low, varying across each platform. From this, we can assume that the only reason investors are still cautious, is due to a lack of awareness and education.

Alternative investment funds can generate a considerable amount of social interest which can further fuel the growth and fulfilment of the required loan, in comparison to traditional loans. The benefit of P2P loans from a borrower standpoint is that they may obtain access to alternative investment funds, that may not have been approved if the borrower had applied through ordinary financial mediators.

Risks of P2P lending

Alternative investment funds, such as P2P loans, may disregard credit history and other factors affecting the borrower, due to an inflated interest paid on the loan. Investors, on the other hand, enjoy higher returns because of the added actual or perceived risk of a small and medium-sized business.

P2P lending isn’t brand new but has become influential over the last couple of years, due to the development of lending platforms and the strengthening of personal relationships between borrowers and lenders.

It can be argued that P2P lending platforms are increasing in popularity and can prove to be a great investment opportunity for some, however, it is strongly advised that the rewards are weighed against the risks prior to making any commitments.\

You need to be aware that when lending through a P2P platform, you will be lending to UK based, small or medium sized business, that carries the usual risks associated with them. Any capital not repaid could be at risk, as well as any outstanding interest payments, and the opportunity cost of future interest payments in the case of a default. Therefore, we always suggest that it’s best to get professional advice when tackling new types of investments.

Benefits of P2P lending

Having highlighted the risks, we also believe that P2P investment platforms actually provide some significant benefits, including;

  1. Investors have the ability to carry out their own underwriting, over and above the underwriting already done by the platform – so you can do as much or as little due diligence to get comfortable with the investment.
  2. You have a choice and can diversify your investments across several loans to manage concentration risk.
  3. The platform will generally only allow loan listings that meet their criteria and pass through a due diligence process. The platforms will carry out checks on the firm, its directors as well as on the financial performance. Platforms like Huddle also never lend without actually meeting the borrower face to face, often at their premises.

Despite the advantages, there are concerns that this new, alternative investment market hasn’t gone through a full credit cycle and many are unsure how it will withstand any shocks in the system, such as an economic slowdown or crisis.

If you are interested in investing through P2P platforms, then consider starting out firstly by learning as much as possible, then invest small amounts to become familiar with the process and the platform. Diversify your risks as much as possible across a few loans. Join forums to learn about the experience of other investors.

The growing size of P2P investment platforms has led some providers to turn to establishing their own banks. This model supports retailers and bigger businesses to invest in the peer loans and fuels the critical need for a steady generation of income across the platform.

Banks are benefiting from this overall change in the P2P investment platform industry, through partnerships that refer less desirable candidates for a traditional loan, to the alternative investment lending provider.

In line with the Small Business Enterprise and Employment Act 2015, nine major UK banks must now, by law, refer SME’s they reject for a loan to an alternative investment fund financing provider. The legislation also details three online platforms that are pre-approved to receive the referrals and match the SME’s to a suitable financing option.

Collaboration allows banks to extend a helping hand to clients that they cannot accommodate, thereby keeping the relationship with the future prospect of the sale of products or services. Equally, the P2P platform receives a steady flow of borrowers, which can often be a challenge to obtain for some.

The increasing popularity of the P2P investment platforms has stemmed from more high-profile individuals and retailers involving themselves in peer lending. This, in turn, has successfully generated further interest in alternative investment platforms.

P2P lending platforms can benefit in a number of ways, from an affiliation with a bank, including; an influx of new customers, an improved trust in the lending brand and access to regulated expert advice.

The recent involvement of banks in this industry has taught the wider business industry about how they can adapt to work alongside potential competitors to improve their offerings. The banking industry has managed to fill in the gaps where the alternative investment platforms may fall short. Utilising years of experience and a strong knowledge of regulations, contracts, agreements, and lending, banks are now profiting from an industry once considered a rising threat.

With the UK’s interest rates at an all-time low, peer to peer lending can offer an alternative investment vehicle, which has shown to offer returns of around 6% APR and more, generally higher than traditional investments. The added returns compensate for the added perceived risk of borrowers and also reflects the lower margins made by these alternative lenders… Want to find out more? Click here.

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