What Could Peer-to-Peer Lending Mean for Banking?
These days, it doesn’t pay so much to save. Yet there is a large disparity between the ultra-low returns for savings and the double-digit rates borrowers are expected to pay for credit, assuming that they can even get credit. With savers getting so little and credit becoming less attractive for borrowers, this large gap has given rise to a new kind of lending. Instead of handing their money to a bank to gain interest, savers can now lend money directly to a borrower for a higher rate of return. This peer-to-peer lending means that the lender and the borrower deal directly with one another, with the bank’s role being cut out altogether. Instead, peer-to-peer lending organisations match lenders with borrowers, making their profit from arrangement fees rather than the interest rates.
How It Works
Peer-to-peer lending, sometimes known as crowd lending, varies in the way that it works, depending on which peer-to-peer lending organisation you choose to use. However, they all work on the same basic principle: that is, they match potential individual borrowers or companies that need credit with savers who are willing to tie up their money for a longer period for a greater rate of return. Since the middleman – the bank – is cut out, borrowing rates are slightly lower, while saving rates can be greatly improved. The peer-to-peer organisation will do all the credit checks on the borrowers before matching them with a lender. They’ll even do the legwork to follow up on repayments if necessary.
The Risks of Peer-to-Peer lending
As it’s a new and innovative form of lending, and a type that has only been regulated by the Financial Conduct Authority since April 2014, there are still many unknowns regarding the risks of peer-to-peer lending. The most obvious risk, of course, is the chance that the money a saver has deposited for lending doesn’t get repaid. Also, depending on how the peer-to-peer organisation works, their money might not be matched with a borrower immediately, so there may be a period where it isn’t earning them any interest. Even though peer-to-peer lending organisations are regulated, there are still drawbacks; they are not supported by the Financial Services Compensation Scheme, which is supported by the government. This would guarantee the first £85,000 per person should the organisation go bust. And even though peer-to-peer organisations are required to have insurance to pay for a third-party collection agency in the event that they do go bust, these risks must still be weighed up against the promise of higher returns on the cash lent. For obvious reasons, this isn’t an option for everyone. However, those prepared to take on the extra risk can enjoy better returns than they could get from a bank or building society.