News analysis: Positives and pitfalls of peer-to-peer

News analysis: Positives and pitfalls of peer-to-peer

Peer-to-peer lending looks set to enjoy a potentially significant shot in the arm when the new ‘innovative financial ISA’ goes live but advisers appear wary of the fledgling sector’s merits.

In its summer Budget, the government confirmed it will launch a new version of the ever-popular tax wrapper in April 2016, which will allow for up to £15,240 to be invested in the peer-to-peer (P2P) sector.

The P2P marketplace has already experienced strong growth, almost trebling in size last year to more than £1.3bn, though that is far below the £57bn squirreled into cash and shares ISAs, according to numbers from Yorkshire Building Society.

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New figures from the sector’s trade body, the Peer-2-Peer Finance Association, shows that more than £500m of new consumer and small business loans have been provided by peer-to-peer platforms since April, the fastest rate of growth yet. Cumulative lending by the sector now stands at £3.15bn.

The burgeoning industry, which matches lenders with borrowers, has risen on the back of the combination of lousy rates of return being offered by cash accounts and consumers having greater difficulty in getting personal loans from their banks.

By going to a P2P firm, both borrowers and lenders can cut out traditional financial institutions. The unique selling point is that while borrowers can enjoy lower rates of interest, lenders can in turn achieve far higher rates of return than they would receive from deposit accounts.

Importantly, borrowers go through a credit-check process and subsequently receive risk ratings, which in turn lets them know at what sort of rates they can borrow at. Lenders, on the other hand, can opt to lend to higher-risk peers for greater rates of return or instead they can offer loans to more solid bets for more modest yields.

The sector has had no significant blow-ups as of yet, but research from Yorkshire Building Society shows that fewer than one in five, or 18 per cent of financial advisers, have or would invest their own money into peer-to-peer lending schemes.

The survey highlights that advisers are most concerned about consumers’ low levels of understanding of the potential risks involved. It found 82 per cent of respondents believe customers do not understand P2P lending rules.

Crucially, P2P is not covered by the Financial Services Compensation Scheme. As such savers could lose capital as well as interest, while also facing restrictions on withdrawing money. Notably, earlier analysis from the building society had found only 42 per cent of savers knew about the FSCS and, of those, 60 per cent were unaware they had no FSCS protection.

Looking at the survey results Andy Caton, executive director at Yorkshire Building Society, comments: “Investing in P2P can offer strong possible returns but people need to be fully aware of the possible risks and costs involved. It is clear many financial advisers have concerns about consumers’ understanding and are unwilling to invest their own money in P2P despite the potential returns.”