R.I.P2P?

Arguably the very essence of the alternative finance revolution, peer-to-peer lending challenged the market dominance of the big 4 banks, unburdened as it was by the constraints of legacy technology and a mindset that said "we have always done things this way".

Of course, the time was 2008-2012, the banks were reeling in the aftermath of the financial crisis, and reputations and balance sheets were in tatters. Bankers hid covertly in the shadows of the Square Mile for fear of being outed as Public Enemy No.1. The time was ripe for something new and the government, equally keen to teach the bankers a lesson, stood right behind it.

Recession is the mother of invention

In university halls, investment banks and bars around the country, bright young innovators were plotting a way of giving banking back to the people. If the banks won't pay decent interest rates to savers, and lend to small businesses and consumers, why not do away with them completely and let people lend directly? Cut out the fat cats and their profits and everyone will be a winner - except of course, the bankers, and who cares about them?

The revolution started brightly. Zopa, RateSetter and Funding Circle were the early pacesetters, quickly gaining traction, defying sceptics and carving out a new language: P2P, crowdfunding, altfi and disintermediation crept into the everyday lexicon.

Elsewhere, Seedrs, CrowdCube and KickStarter, were doing the same for equity investing.

There was definitely a buzz in town.

As the buzz turned into a cacophony, more and more people were drawn towards the party. All you needed was a web developer, a Google Ads account and a gregarious CEO for the PR, and you were good to go. A willing investor to pay for the developer was a handy addition, and there were plenty of those in town too.

Soon, the FCA twigged there was something going on and got in on the act with some light regulation to protect the most vulnerable. The edict from government, though, was don't throttle the prodigal child at birth.

Fast forward a couple of years and P2P was behind nearly every new brand launch in financial services: SME loans, working capital products, property investment, consumer loans, equity investing. You name it, P2P was the new black.

But then things started to go wrong.

The platforms weren't making any money and some started to fail. Most slipped quietly beneath the waves, but others collapsed in ignominy, leaving investors out of pocket and only the administrators rubbing their hands.

The FCA, in fear of being caught asleep at the wheel, acted with tougher and tougher regulation, making authorisation increasingly complex, and effectively legislating the retail investor out of the market.

The arrival of new platforms to the market slowed to a trickle.

Five causes of failure

So, what precisely did go wrong, and as importantly, where is the future in the P2P model?

I think we can point to five main flaws.

• The cost of capital is too expensive

To encourage an investor to move capital from the safety of a bank account to the risky world of lending requires a significantly higher return. Add to that platform costs and you get an interest rate for the borrower way above what is available from the banks. The myth was the banks weren't lending, but they were to the good customers, which leads to another point.

• Lending money isn't easy

The PR machine for the new industry derided the IT systems and lethargy of the banking industry, but failed to respect the years of experience that sat behind some of the admittedly long decision making processes. The doors never closed to the lower risk customers, it was the higher risk ones that got pushed to the margins.

• Finding new borrowers is an existential risk

Having persuaded investors to sign-up and deposit their money, platforms can only keep them there if they have sufficient borrowers to deploy the cash to. But finding borrowers is expensive and once found, there is a reluctance to let them go. This leads to high risk lending, or there not being enough readily available capital to fulfil the loans that are agreed (rather undermining the argument that P2P lenders are quicker than the banks).

• Platforms don’t have enough sources of early revenue

Most platforms are monetised on the basis that they take a small share of each interest payment collected from the borrower - a microscopically small amount of money that needs substantial scale to cover launch and ongoing operating costs. Most got nowhere near either. Some charged an upfront arrangement fee (many didn't) and few created sufficient margin between what they were charging to the borrower and paying to the lender: a basic principle of banking.

• The value proposition for the borrower is undifferentiated

Strip away all the hype of tech platforms, fast decisions and a lender that will care for you, and you find an analogue process based on spreadsheets and photocopied bank statements. There is no fundamentally compelling reason for a borrower to choose a P2P lender other than it might lend when others wouldn’t.

The smart platforms learned quickly about the scarcity of capital and cottoned on to the fact that it had to come from institutions. Now it was the hedge funds and family offices that were receiving the platforms' eager solicitations. P2P lending was redefined as marketplace lending - an awkward neologism that never really caught on.

The institutions, however, were only interested in the platforms that could demonstrate the ability to lend at scale, so the capital flowed towards the few market leaders leaving the others to feed on what they could gather from the retail market. Of our early rising stars, Zopa has become a bank, RateSetter has sold to Metro (and removed the P2P element) and Funding Circle is entirely institutionally funded. The hoodies have turned into suits.

Evolution of the species

So, who has bucked the trend?

Only in the world of property do we see the P2P lending model really thrive: Assetz, Proplend, BlendNetwork, Kuflink, Invest & Fund and CrowdProperty are amongst those worthy of commendation, both for their longevity and the favourable reviews they achieve from sites like 4th Way.

The concept of fractional property lending clearly appeals to investors who don't want the hassle of being a landlord. The banks are still wary of lending to small property developers and landlords, and interest rates of 1% per month are normal in the market. This allows a healthy return for platform and investor alike. Upfront arrangement fees provide an early source of income, and the security that comes from low loan-to-value (LTV) exposures means that these better platforms have been able to insulate investors from losses when projects go wrong.

Before we get too carried away, though, we should remind ourselves that the P2P property sector has seen its share of collapses too. Take a bow Collateral, Lendy, Funding Secure and The House Crowd.

In non-property business lending, honourable mentions go to Ablrate and ArchOver who have kept their doors open and the P2P flag raised (both with an element of property). As far as I am aware, and I'm sure somebody will correct me if I'm wrong, there is nobody left offering peer-to-peer consumer lending following the exit of Lending Works last month.

Another place where P2P is firmly established is equity crowdfunding. The purists will point out that this isn’t P2P lending and they are right to do so because it explains the different fortunes. A small equity investment in a new business idea has a very different appeal to an investor who accepts that the chances of a return are low, but the rewards, if they come, could be high. For the entrepreneur, it opens a channel to a breed of angel investor that didn’t exist before. The platform can earn risk free income from a listing fee and then more when the deal is funded. Many of the problems of the P2P lending model have been overcome.

Finally, a mention for cause-based P2P, or micro-finance, namely loans to very small enterprises, often in developing nations. Here too, we are seeing the peer-to-peer business model work, most likely because the investor sees it as a hybrid between a loan and a donation.

The wisdom of hindsight

Readers of this blog will look back over its history and find plenty of articles supporting the P2P movement. There is no hypocrisy in this. I am proud of the clients we supported and the part we have played. The flaws evident in hindsight were not so obvious at the time (although I am on recordpointing out some of them!), and the market definitely needed shaking up following the shambles of the financial crisis.

Let's remember, we wouldn’t have established brands like Funding Circle, MarketFinance and Zopa keeping the big 4 banks on their toes without P2P. Even if these businesses are very different beasts now, it was P2P that got them started and P2P that got them known. The financial services landscape would be much less competitive and innovative than it is, and for that we can be grateful.

If this then is an obituary for the fallen, the epitaph on the tombstone should be:

“Nothing great was ever achieved by doing things the same as everybody else”.

Photo by Matthias Müllner on Unsplash