What is Peer-to-Peer Lending?

Learn about the peer-to-peer lending landscape in the UK as we cover everything from the history of P2P lending to the risks involved today.

Updated on 20/11/2020

In times of financial hardship, traditional lenders such as banks may not be able to offer loans at their usual rate. Instead, they might limit who they’re willing to lend to, out of concern that borrowers may not be able to pay back the funds.

On top of these difficulties, traditional loan applications could be more time-consuming than their modern online counterparts; taking longer to complete and potentially seeing funds move more slowly. This can make it difficult for businesses to get access to finance during periods of economic uncertainty.

That’s exactly what happened in the 2009 recession, and it sparked the explosive growth of the peer-to-peer (P2P) lending industry in the UK. A growing demand for quick access to loans grew amongst small businesses, and there were limited options in the market at the time that could meet this demand effectively.

Business owners needed finance that:

• Was quick to access
• Didn’t involve huge amounts of paperwork
• Had competitive interest rates

That’s what P2P lending proved to be able to deliver on, to an extent. In this article, we’re going to explore the realities of peer-to-peer lending in the modern day, weighing up the pros and cons of this type of financing.

So, who are these peer-to-peer lenders? Well, one category is P2P lending platforms. Anyone can invest in a P2P lending platform, such as Ratesetter or LendingWorks, and the platform would then loan money to a small business. Afterwards, the investor would receive a portion of the interest generated through the business’ monthly repayments. It’s a potential source of passive income that your typical investor might include as part of a diverse investment portfolio.

The evolution of these P2P lending platforms has spurred on the growth of dedicated online business finance providers that want to offer a similar set of benefits and compete with them- and that’s where Esme sits. The idea behind our company was born during an ‘innovation cell’ conversation within NatWest, as a response to the type of P2P lending platform we’ve just identified, and to take the stress out of lending and give SMEs the finance they need to thrive. Lenders in our position also want to offer the attractive benefits of having quick access to funds, paperless application processes and competitive interest rates- which is something that is often more achievable through the unique position online lenders are in.

We’ve highlighted some of the benefits of P2P lending and the history of lending itself, but it’s important to give a rounded perspective as to how applicable these benefits are during coronavirus. Lending appetites may have decreased for many lenders in the UK given the difficult position businesses find themselves in and the resulting impact on their ability to repay loans.

What that means in a practical sense is that many lenders grade borrowers on a scale from A to E based on how risky they feel it may be to lend to them. In an ideal world, a lender would probably like to lend to as many prospects as possible, provided they meet their robust eligibility criteria and pass their risk-assessment processes, however this may not be the case during coronavirus. Lots of P2P lenders may instead opt to only lend to A – B grade prospects, thereby reducing the risk of them facing missed repayments in future.

Tighter lending grades could mean that to get access to business funding, your business may need to prove that it has been trading for a substantial length of time, has a track record of making profit, and a host of other potential criteria which vary from lender to lender. Be sure to read the fine print and check a lenders’ eligibility criteria before making a loan agreement.

Whether a business is lending from a P2P lending platform or an independent digital lending platform, some advantages they may enjoy are:

• Fast decision times - often online lenders utilise automation that can help speed up the risk assessment process and therefore accelerate decision making.
• Quick access to capital - online lenders are typically able to get funds in a borrower’s account quickly once their checks have been made and a loan agreement is finalised.
• Less risk of equity losses for borrowers - there are a huge range of P2P lending options available from different providers, so there’s a good chance you won’t be required to give up part-ownership of your business in exchange for securing finance. But you should always check for this and do your research before agreeing to a loan’s terms and conditions.

The disadvantages of P2P lending centre mostly on risk, safety, and regulation - with the industry being regulated by the Financial Conduct Authority (FCA). Let’s take a closer look at those elements.

When P2P lending was new, there was a good chance that many businesses felt uncomfortable borrowing money from an online business loans provider. After all, there was an unfamiliarity around digital lenders when compared with traditional banks.

However, bank lending growth rates have hit a record high, spurred on by the government’s decision to accredit some banks and online lenders as CBILS and BBLS providers, and this indicates that more small businesses are in need of financial support than ever before. As a small business that’s in need of finance, then, what can you do to make sure the lender you’re conversing with is reputable?

Look for the proper accreditations on the company’s website and do your research. A strong indicator that an online lender is reputable is if it’s registered with the Lending Standards Board, and therefore commits to complying with their requirements around delivering a good lending practice. The UK’s financial sector is one of the most heavily regulated in the world, so many lenders will want to showcase their accreditations to customers in order to instil confidence.

Some of the key risks around P2P lending in 2020 include:

• P2P lenders may tighten their eligibility criteria, therefore making it more difficult for borrowers to access funds.
• P2P lenders always run the risk of borrowers defaulting and being unable to make repayments – a risk which is particularly prominent given both the severe challenges businesses face daily, and ever-evolving consumer needs.
• The interest rate associated with a peer-to-peer loan delivered by a P2P lending platform may be higher than the rate you’ll find offered by a dedicated business loans provider.

All in all, we expect that the industry will continue to offer even more attractive benefits and options to borrowers as the technology behind lending services evolves and automation makes processing applications even easier.