Peer to peer lending could offer substantial returns and provide lifeline to SMEs
Investors need to beware the risk of bad debts and the lack of any regulation
Rogue bankers may have done more for good corporate governance than specialists in that field could achieve in a lifetime. Designing incentive schemes to align bankers’ interests with those of shareholders has not worked – bonus is almost an evil word these days. Neither, as former taoiseach John Bruton recently observed, has excessive regulation.
Last week, the UK’s Commission on Banking called for stronger criminal sanctions to be imposed on those running its largest banks – on top of the heavy regulation they currently face.
There is a simpler solution: Impose losses directly on those who make reckless lending decisions.
Under the current system, bankers can walk away from flawed loans, leaving shareholders and the taxpayer out of pocket. Thanks to internet technology, and the current state of dysfunctional banks, a new industry has mushroomed known as peer-to-peer lending (P2P).
In essence, if you are a small firm or individual looking for a loan, there are internet sites that can match you to people who have spare cash that they wish to invest. The investor makes the decision to lend and then he or she suffers if the borrower defaults. This leads to improve corporate governance.
The British government has recognised its potential. As in Ireland, attempts to revive lending to small and medium-sized enterprises (SMEs) through conventional banking has failed. So now it has allocated £20 million (€23.5 million) to a P2P firm.
It says: “We set up the Business Finance Partnership to invest £1.2 billion in increasing lending to [SMEs] from sources other than banks. This money is being matched with at least an equal amount from private sector investors and will be invested on fully commercial terms.”
Andrew Haldane, the Bank of England’s executive director for financial stability, also sees its potential. “At present, these companies are tiny. But so, a decade and a half ago, was Google, ” he has said.
According to LinkedFinance, a new Irish P2P company, €40 billion was lent to small businesses last year, well below demand. At the same time, people have about €90 billion on deposit earning low rates of interest. Clearly opportunities exist.
LinkedFinance, which has the backing of Enterprise Ireland and Senator Feargal Quinn, started operating last March. To date, it has advanced €412,000 over 12 loans, according to its founder Peter O’Mahony. O’Mahony says that, under the conventional banking system, savers get at most 2 per cent while borrowers are charged about 10 per cent: that’s a gap he hopes to close.
The service charges an upfront fee to successful borrowers of 2.5 per cent and 1.2 per cent per annum to investors. The total charge between borrower and investor spread out over a typical three-year loan equates to about 2.1 per cent. That’s a substantial reduction on the eight percentage point gap, though you still need to factor in the interest rate sought by the investors and the risk of bad debts.