As savers and borrowers are both being ripped off, they should consider peer-to-peer lending with its excellent returns
Banks enable us to lend to and borrow from strangers, which makes modern capitalism possible. But they take a hefty cut and big risks, and when things go wrong, as we saw in 2008, the taxpayer bails them out. So does the Bank of England, shovelling cheap money into the financial system, meaning skinflint returns for savers. Yet those of us wanting to borrow money to buy a car or to raise working capital for a small business still pay stonking interest rates.
This cost-heavy, barnacled, old-fashioned industry is ripe for competition and rationalisation. Just as Skype has made international phone calls — once an extortionately priced luxury — practically free, and Uber has shaken up the cosseted taxi market, new technology also enables upstart financial services companies to challenge the status quo.
For the past few years I have been lending my money to total strangers but without a dinosaur bank taking its cut. Instead I use the mammals of the financial ecosystem: peer-to-peer lending platforms such as Zopa, Funding Circle and RateSetter. These slice my savings into tiny chunks, mix them up with other lenders’ money and issue them as loans — £5 billion over the past six years, to nearly 350,000 borrowers. Unlike banks, they don’t lend their own money. They just help me lend mine.
Computers and the internet make that possible: in effect, taking a slice of the business of collecting deposits and selecting borrowers that bankers have monopolised for centuries. Peer-to-peer lenders have skinnier costs than banks: no branch networks, no gleaming corporate headquarters, no pinstriped geniuses wining and dining each other at our expense.
Cutting out the middleman means returns are excellent; I have been earning 5-8 per cent annually from the British platforms. Elsewhere, returns can be even spicier (if riskier). On an Estonian platform called Bondora, which lends in euro, I have been getting double-digit returns over the past four years. It’s not just the money. I also enjoy the control (on some platforms you can choose who you are lending to) and most of all the feeling that I am bypassing the greedy and incompetent middlemen of the banking industry. Bailouts and subsidies mean they get quite enough of my money already.
There are disadvantages. Chiefly, my money’s at risk. If a bank goes bust, the taxpayer insures each depositor’s money up to £75,000. Peer-to-peer platforms are not covered by that guarantee. If my borrowers go bust, I could in theory lose some or all of the money I lent.
Though banks are not very good at finance, they are excellent lobbyists. They are trying, by drip-feeding rumours and scare stories to regulators, MPs and the media, to portray the nimble upstarts as risky, ill-run and doomed
So far, that danger is only theoretical. If a few slivers of my lending go sour, the interest rate I am receiving on the rest covers it. Just as banks spread risk, so do I. On Bondora, which lends in Estonia, Finland, Slovakia and Spain, bad debts have dented my returns by 2-3 per cent to a net 17 per cent. But I have nearly doubled my money. Most of the big British platforms have their own back-up funds, supported by a levy on the fees charged to borrowers, which insure savers against the risk of default. These have not been tested by a big crisis but no lenders have yet lost money.
Many questions remain: how far is the peer-to-peer industry’s spectacular growth a macro-economic fluke, the result of freakishly low interest rates and the banks’ gun-shy approach to lending since the financial crisis? Are borrowers being properly screened? Who gets first pick at the best loans, and are the worst ones fairly allocated? At the bottom of the market, peer-to-peer platforms are competing with doorstep lenders, payday loan companies and other unsavoury providers of cash.
As in any new industry, some of the entrants are proving flimsy or reckless. Respectable British platforms suck their teeth at the jauntier newcomers (and have formed a trade association to set some rules). America’s biggest peer-to-peer platform, Lending Club, has had a dreadful year, plagued by scandals, potential prosecution and — as I know to my cost — a plunging share price. Most platforms are putting growth ahead of profitability.
However, the potential is huge: the mammals are gobbling market share all over the world among people ripped off by the dinosaur banking industry. They offer better deals for savers and borrowers. For taxpayers, mammalian finance is fundamentally less risky. If a bank goes bust, the financial system wobbles as depositors wonder if they will get their money back. If a peer-to-peer platform goes bust, only its owners suffer.
The dinosaurs, unsurprisingly, are trying to stamp on the mammals before this goes too far. Though banks are not very good at finance, they are excellent lobbyists. They are trying, by drip-feeding rumours and scare stories to regulators, MPs and the media, to portray the nimble upstarts as risky, ill-run and doomed.
One result of this lobbying has been to delay approval of the main platforms’ “alternative finance” Isa, which would let savers earn tax-free interest: a powerful competitor to the derisory (1 per cent or so) returns on the banks’ own cash Isa offerings.
Peer-to-peer lending is, supposedly, too risky for humble investors. In truth it is far riskier to own shares (not least, one might add, in banks). Nobody complains that these are allowed in Isas.
The mammals do have weaknesses but the best way to expose them is by competition, not by pampering the dinosaurs, especially when their greedy antics impose such colossal risks on our financial system.