The Government is throwing itself behind the sector: the new British Business Bank is pouring £40m into Funding Circle, from April peer-to-peer loans will be eligible for inclusion in ISAs, and changes to tax rules will allow losses to be offset against gains.
The crowdfunding business model is presented as ‘cutting out the middle man’, bypassing unhelpful banks who are not lending to SMEs and interest rates which are at a virtual meaningless levels for funds held on deposit.
RBS themselves will be sending borrowers that they don’t fancy lending money to to peer-to-peer lenders, which given the feedback of many SME owners I speak to could mean a hell of a lot of potential new crowdfunding business.
It’s a narrative that chimes with the times, but that makes it easy to overlook the fact that the risks involved in peer-to-peer lending are very different from those taken by savers with High Street bank deposits:
Most platforms assist lenders to diversify their exposure to each borrower, so that each lender has exposure to a small part of many different borrowers’ loans, but it is worth noting that deposit guarantee (the first £85,000 of bank deposits are Government guaranteed) does not apply with this Crowdfunding.
This apparent diversification belies the frailty of the business model: they are similar loans that are likely to be highly correlated. Peer-to-peer lending has grown up in a relatively benign economic environment, and a highly benign interest-rate environment. A downturn in the economy could put a significant proportion of borrowers in trouble at the same time.
Last month the FSA rebuked peer-to-peer platforms for comparing their products to savings accounts, and more recently it criticised equity crowdfunders for misleading customers. But the hype runs deep.
Last weekend’s Sunday Times presented a table comparing the 12 per cent p.a. “top possible return after typical defaults and fees” for peer-to-peer lending with 3.3 per cent p.a. for a 5-year savings account and a 3.6 per cent p.a. prospective yield on equity income funds and banks deposit at below 1 per cent.
Peer-to-peer platforms typically talk of an expected net return around 6 per cent p.a. which is clearly 6 times that of bank deposits so with pensioners now able to manage their own pension pots should they rush to drive their mini past the Lambourghini garage to the nearest crowdfunding company to lend some of their retirement funds to small business and private individuals looking at these alternative lending options? The simple answer to that question is yes as whilst there are obvious potential failings and there is the potential that bad debt could feature as opposed to your government backed deposit banking the simple economic risk and reward comes into play.
You could invest your money in a basic FTSE 100 fund which has produced returns of 9.8 per cent and 9.2 per cent p.a. respectively over the past 3 and 5 years. An investor tucking money away for some time is still likely to do better putting money in a FTSE tracker than in peer-to-peer loans.
I’m sure there’s a place for crowdfunding in portfolios, especially for more sophisticated investors or those with an almost philanthropic ethos because as a friend pointed out to me recently equity crowdfunding is very similar to gambling on the horses as you should never use money you want see again and when you do it will be a bonus.