Should you be worried about peer to peer lending?
Peer-to-peer lender Funding Knight has been rescued by investment firm GLI Finance, potentially rescuing 900 investors who are at risk of not getting their money back after the company entered administration last month.
Peer-to-peer lender Funding Knight has been given a cash injection by investment firm GLI Finance, potentially rescuing 900 investors who are at risk of not getting their money back after the company entered administration last month.
Funding Knight entered administration on 28 June, and company director Graeme Marshall announced his resignation two days later. An administrator was appointed on 6 July.
But GLI Finance has since injected £1,000,000 into Funding Knight, protecting investors - who were promised average returns of 8.96% - from losing their investments, at least in the short term.
Funding Knight’s accounts show that GLI had already lent £750,000 to the business before it went into administration, at terms that entitled it to 12% interest.
Elsewhere in the peer-to-peer market, analysts at data firm AltFi have warned that growing bad debts at RateSetter could also put investors at risk of losses.
RateSetter runs a provision fund, which means some money from all borrowers is put aside to provide an element of protection against default funds.
AltFi’s analysis suggests default rates (borrowers not repaying loans) have been unexpectedly high, which could drain the provision fund empty, ultimately resulting in losses for lenders.
However, RateSetter disputes AltFi’s analysis. In a response article on Altfi’s website, it admits that bad debts were higher than expected for lending in 2014, when the company was growing rapidly. But it says that in the long term, the provision fund will run at a surplus, as it did between 2010 and 2013.
Peter Behrens, the company’s chief commercial officer writes: “We recognise that our model stands or falls on our ability to underwrite credit and to provide appropriately, all within the confines of remaining competitive.
“We are not complacent and over the last two years we have made some important refinements. For example, we have prudently chosen to collect more Provision Fund contributions over the lifetime of our loans, rather than taking the entire amount upfront, which we believe is a sustainable and fair model.”
So should investors be worried?
Both of these stories should remind investors that peer-to-peer lending is much riskier than a savings account, and the risk of losing money is very real.
Money saved with a licenced deposit taker, usually a bank or building society, is guaranteed, meaning you the bank guarantees you will get your money back plus interest. Even if the bank is unable to pay you back, the Financial Services Compensation Scheme (FSCS) guarantees your savings up to £75,000. Investments in peer-to-peer lending platforms are not guaranteed or covered by the FSCS.
That’s is true of all peer-to-peer lenders, but it’s also important to understand that the risk of losses isn’t the same for every peer to peer lender, as it depends who they lend to and how good they are at predicting defaults.
Some firms will only invest to consumers, others, only to businesses and others will lend to both.
Funding Knight exclusively lends to businesses (including green energy projects and property developers). RateSetter primarily lends to consumers, but a substantial proportion of its loans are to businesses.
Generally, lending to businesses rather than consumers is seen as riskier, as it’s harder to understand the likelihood that someone won’t repay a debt.
That point was best made by Lord Adair, who warned of problems brewing in the peer-to-peer sector in February. Speaking to the BBC he said that in the next five-to-ten years losses in the sector could “make the worst bankers look like absolute lending geniuses”.
At the time he argued platforms that lend to businesses instead of consumers needed more thorough assessments.
“You cannot lend money to small and medium enterprises in particular without somebody going and doing good credit underwriting,” he said.
“This idea that you can just automate that on to a platform, I think it has a role to play but I think it will end up producing big losses.”
By contrast, Zopa, which launched in 2000 and has lent over £1.5 billion so far, will only lend to consumers, and it’s very picky with who it will lend to. The company says only 15%-20% of applicants are accepted.
That’s not to say that Zopa is risk free, but to date, its default rates have been much lower than it anticipated, according to monthly default rates published on its website, which say that it planned for a default rate of 2.88% in 2015, but actual defaults have been just 1.15%.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.