Over the last twenty years a great number of major international industries have been turned upside down by technology.
Old, entrenched market leaders have been replaced by new models, from travel with the fall of agents; to music with the rise of downloads; to retail with new online monoliths Amazon and eBay. The same transformation is now happening in financial services, and crowd funding and peer-to-peer lending are at the centre of this transformation.
Peer-to-peer lending is about taking out the middle man from the act of borrowing or investing money, so your money doesn’t get frittered away on servicing expensive branch networks that only a small minority continue to use, or on paying fines to the regulator, or on large-scale advertising campaigns. The benefits therefore are simple: borrowers get a better rate and service than they can elsewhere, and investors get a good return on their money.
As with any investment there are risks associated and there are ways to mitigate those risks.
The first thing to understand is that different forms of peer-to-peer lending or crowd funding carry different levels of risk. Equity crowd funding platforms naturally carry greater risks than debt based platforms, and within debt based platforms there are also differing levels of risk. Investing through MarketInvoice – which offers short term working capital finance backed by a verified invoice owed by a blue chip – is less risky than investing in a five year term loan, where you’re reliant on long term small business success, rather than a submitted invoice being paid in the next 45 days.
As ever, the best way to alleviate investment risk is to ensure you have a diversified portfolio of investments such that if one fails, your overall returns aren’t hit too hard. Given the number of different borrowers and products across peer-to-peer platforms it is possible to have an extremely well diversified portfolio of peer-to-peer investments.
Communication is crucial. Peer-to-peer lenders need to lead the way in offering transparency to their investors – this is another area where they can make significant headway on larger incumbents. It is vital that investors are aware of the risks and I would expect the regulator to keep a close eye on this, paying particular attention to those who might not have a history of investing.
It is a common misconception that businesses borrowing through peer-to-peer lenders are bank rejects and that they are of dubious credit worthiness. This is wrong on two counts:
Firstly, the credit scoring models of banks do not reflect the nature of many modern businesses. Banks like to offer business finance where they can take significant security over business assets. For many modern businesses, like software developers or graphic designers, their business has few assets beyond their computers, and so despite being successful businesses with strong track records, they can’t get bank finance.
Peer-to-peer lenders operate credit scoring models which more accurately reflect the modern economy. Default rates over the last few years, therefore, have remained below that of the banks – and that’s in a turbulent economic climate.
Secondly, many of the businesses using peer-to-peer finance haven’t been rejected by a bank, they’ve just chosen to take the better borrowing rate. At MarketInvoice four out five of our clients have never used bank invoice finance before. This is because the products on offer from peer-to-peer lenders are superior, and not just in terms of rates but also in areas like speed, transparency and customer service. Good businesses are choosing peer-to-peer over the banks, and this is a trend that will extend further into the market in the coming years.
Peer-to-peer lenders will live and die by defaults.
As the sector grows it will become easier and easier to compare returns across platforms – net of defaults and fees – and the money will follow the best returns. The next 18 months will be an interesting period for some platforms as the first longer term loans begin to mature. For MarketInvoice – our short term loans have shown already that the model can be made successful with rigorous risk processes and careful communication.
Financial services will benefit from technology led disruption. Old models of finance based on cross-selling, customer apathy, and captive relationships are being re-invented by the new generation. The products on offer can benefit not just the investors and borrowers, but the economy as a whole, helping drive exports, job growth and new innovations.