Peer-to-peer (P2P) lending is a disruptive technology that traditional banks can no longer ignore.
Peer-to-peer (P2P) lending, a fintech-driven innovation that has taken banks out of the equation by simplifying and changing the value chain, is a rapidly growing market with £715 million lent in the UK during the first three months of this year alone. The benefits of the sector are obvious with interest rates that are lower for the borrower and higher for the lender than those offered by the traditional banks.
Indeed the rise of P2P lending has led to the Bank of England concluding that it could become a major force within financial services over the next decade or so; something which should be further accelerated by the launch of the tax-free Innovative Finance ISA in April.
So, the question is: will traditional banks embrace this disruptive technology or compete against it?
Peer-to-peer versus the banks
Initially banks were complacent as P2P took away some riskier lending at the fringes at a time they were looking to de-risk their lending portfolio with the Prudential Regulation Authority (PRA) reviewing risk-adjusted capital ratios and capital holdings generally. The principle of P2P lending is to use state-of-the-art platforms, which bypass traditional banks and enable the lending and borrowing of money at more favourable rates than those offered on the high street.
Since P2P pioneer Zopa launched in 2005 it has facilitated the lending of more than £1.3 billion from across 50,000 lenders by offering returns on investment which regularly exceed 10% at a time where interest rates within the UK have been historically low. This rate of growth is remarkable, but not unique, within an industry which faces a number of challenges, such as not being covered by the Financial Services Compensation Scheme, the risk of fraud, and the threat of platforms becoming bankrupt and losing investors' money.
Bank complacency is changing
The complacency of banks towards P2P lenders seems to have shifted recently for three reasons.
The first is that as P2P has become more popular and mainstream it has become more of a competitor, which has taken away from the bank’s intermediation role and reduced its profit opportunity. The second is that this rise in popularity has come at a time when banks have been struggling to lend with many holding a surplus of liabilities due to cheap access to customer savings. And the third is that as the global demand for P2P finance has grown the platforms are increasingly looking for traditional banking organisations to provide funding to continue their rapid growth, which has led to a number of high street banks joining partnership with P2P firms, as evidenced by the partnership between Santander and Funding Circle.
Our expectation is that the P2P sector will continue to grow in the medium term, particularly while interest rates remain low and consumer confidence in the technology rises. It is also likely that the evolution of this nascent industry will see greater levels of integration and collaboration between the traditional banks and the platforms over the next five years, with a high degree of experimentation within the sectors business model.
Challenges ahead for financial services
Two of the bigger challenges for the industry appear to be mitigating the impact that a high-profile failure would have on the sector as a whole and the lack of a history over the full credit cycle.
The former challenge is expected to result in greater operating costs due to an increased regulatory focus while the latter has led some to suggest that the P2P market for small to medium-sized businesses has all the hallmarks of what happened to personal credit pre-2007, whereby access to loans for subprime borrowers was readily available.
The P2P industry once again highlights how traditional banking services are having to adapt as a result of fintech innovations and how these disruptive technologies are affecting the financial services status quo.
Words: Ben Coyne, Financial Services