Peer-to-peer (P2P), or marketplace, lending is being tipped as the next big thing in finance – both for small businesses and consumers. In some senses, it already is. Even the British government has noticed, and is working with lenders to ensure that they get the support they need.
So why all the fuss? Why is the government getting involved in alternative finance, P2P finance in particular? It’s partly political, of course, and partly because P2P finance has the capacity to shake up small business lending pretty dramatically.
So, how does it work? The platforms are quite simple and it’s almost all managed digitally. Businesses that want to borrow money put themselves in front of potentially thousands of investors by signing up to the platform. Once credit screening and due diligence has been done, investors can choose whether to invest in the company – from as little as a couple of pounds, all the way up to a few thousand. Then, if the business receives all of its funds, the round is closed and the borrower gets the money, repaying at the agreed interest rate, as they would with a loan from a bank.
The key differences with a bank are pretty obvious. The clearest: businesses are borrowing from potentially hundreds of people – though the borrower of course only gets the money in one big lump sum. Second, the process is almost entirely digital. There is no going into your bank branch and all information can be uploaded and money lent online.
These two innovations are what make P2P finance so exciting. Crucially, the highly automated processes and low overheads mean that businesses could get seriously low borrowing rates. Additionally, each investor on a platform can lend to a number of different borrowers, spreading their risk while keeping high returns. Finally, while the platforms are technically the middle-man, banks take a large wedge in interest, between the rate you get when you save money and the rate you get when someone borrows money. These platforms almost eliminate this wedge entirely by directly connecting investors and borrowers.
The UK’s alternative finance industry has taken another step along the road to mainstream acceptance with the promise of a £40m investment from the British government. Financial Times
It’s tedious to keep bashing the banks and in reality, when it comes to lending, the costs involved for banks, given their enormous infrastructure, make SMEs a really unattractive prospect for credit. Loan values are simply too small to make profits. The bottom line is this: P2P finance providers like Funding Circle offer a real solution to a big problem – and that’s why everyone is getting excited.