Peer-to-peer lending is often associated purely with consumer lending and borrowing, but the enormous potential of the business lending market could spell huge growth for the industry. Just as long as platforms are prepared to do a bit of hard work…
Consumer lending gets an awful lot of attention in the peer-to-peer world – after all, the very concept of P2P lending was introduced as a way for individuals to lend to and borrow from each other. But as the sector matures, it is becoming more and more apparent that the real growth opportunities lie with business lending.
One business loan can have the same value as 10 (or more) consumer loans but with one tenth the effort and the interest rates can be tantalisingly high. In most cases, these businesses are turning to P2P lending after exhausting the traditional routes to funding – private investment and banks – so the investors can set their preferred rate of interest.
While these interest rates may put off some businesses, they are – understandably – incredibly attractive to investors. Most P2P platforms perform their own rigorous security checks on the businesses and the vast majority of P2P business loans are asset-backed, making them an attractive prospect for lenders even before they consider the potential returns.
“The interest rates have stayed relatively high for businesses,” says Kevin Caley, chairman and founder of ThinCats. “We put the loans up and ask our investors what interest they would like. And our lenders have got a bit greedy.”
Attracting business borrowers
But while the investor appetite is undeniable, attracting the businesses is another story. Last November, the UK government launched the bank referral scheme, which encourages banks to refer businesses to P2P platforms as an alternative source of funding. The scheme is still in its infancy, and platforms have not yet seen a big knock-on effect, but it has been lauded for bringing P2P business lending into the mainstream.
“The bank referral scheme has definitely raised awareness of the sector, and business owners who have sat on the fence when it comes to P2P may feel more assured if they are referred to a P2P lender through the scheme,” says Paul Goodman, chairman of the National Association of Commercial Finance Brokers (NACFB). “But it’s important that businesses directed through the bank referral scheme are given the right advice and are advised about a range of funding options, including P2P, that are most suitable for their business needs.”
The government initiative has already been adopted by RBS, Lloyds, HSBC, Barclays, Santander, Clydesdale and Yorkshire Bank, Bank of Ireland, Danske Bank and First Trust Bank. These banks are encouraged to pass on the details of small businesses they have rejected for finance to three aggregator platforms (Funding Xchange, Business Finance Compared and Funding Options), who then share the details with P2P lenders.
At the same time, NatWest announced its own referral scheme, partnering with P2P platforms Funding Circle and Assetz Capital.
Proceed with caution
And while P2P lenders have welcomed the opportunity to gain access to thousands of businesses, they are approaching these bank referrals with caution.
“We’re supportive of the scheme in principle, as we know that there are many good businesses out there who are being turned away by banks for the wrong reasons,” says Paul Marston, managing director, commercial finance at RateSetter. “RateSetter is involved in the scheme, but we’re looking for very specific kinds of business: ones that might not fit arbitrary criteria but are still creditworthy. Our assessment is primarily based on whether a business can afford the repayments across all of its commitments – and with people on the ground across the UK we can make detailed assessments.”
In fact, bank referrals have been happening on a more informal basis for the past few years. Most platforms are already working with accountants and brokers to secure new business clients, while ThinCats has been operating its own small-scale bank referral scheme for years.
“What we have found is individual bank managers get approached by people who want to borrow money and because of restrictions on the bank they have to say no,” says Caley. “If those people come to us, we can offer them more security and the bank doesn’t have to lose the customer’s banking business.”
By building up personal relationships with bank managers and making regular calls to the bank branches, Caley says that ThinCats has already received a few high-value business referrals. Meanwhile, other platforms rely on a variety of techniques to attract new loans: from large-scale advertising campaigns, to word-of-mouth recommendations, and close relationships with accountants and advisers. This has led to a significant uptick in the number of business loans being offered either through business-only platforms, or alongside consumer loans.
“It’s all about raising awareness and explaining our proposition,” says Marston. “Naturally we do all we can to spread the word in the business community – that takes the form of advertising, being at the right conferences, winning awards and simply talking to as many businesses as we can, as well as sharing customer success stories.”
These success stories will play an important role in convincing businesses that P2P funding is a viable alternative to banks. According to NACFB data, there has actually been a slowdown in P2P borrowing over the past year, although Goodman adds that “that’s not altogether surprising as the P2P sector has grown at such a staggering pace.”
Furthermore, there is still a lack of understanding among many SME owners about P2P and what it entails, and Goodman believes that this will only grow as the sector expands.
“It’s important that P2P lenders continue to educate the market and are transparent about their business processes, particularly when it comes to their underwriting criteria,” he says. “P2P is now an established alternative finance option and will always have its place, but businesses shouldn’t automatically turn to P2P if they are rejected for a loan by their bank.”
At the moment, there is a clear imbalance between investors and borrowers, with ThinCats’ platform running a surplus of £7m from investors keen to take advantage of the high interest rates available.
“When we put a loan up now it goes pretty quickly,” says Caley. “That indicates that there’s a movement towards more realistic interest rates. If our interest rates start coming down then more businesses should start coming to us and we should get more deals.”
In preparation for these new deals, ThinCats has been expanding its team – from nine employees last year to more than 30 in 2017 – and mulling a Zopa-style cap on new investors to avoid overcapacity. The recent acceleration of IFISA authorisations has left many platforms anticipating a flood of new investors before the end of the current tax year, so the race is on to bring in new borrowers. However, this brings with it another element of risk.
“There are two ways to increase capacity,” says Caley. “Increase the deal size or increase the number of deals.
“Lenders are either going to have to lower their standards or do something to make those loans more viable. I hope they aren’t going to do that because it will make the industry look bad.”
There is certainly huge potential for growth, if it is done properly. Business banking is worth approximately £100bn annually, and last year alternative finance index OFF3R valued the P2P sector at a comparatively tiny £2.6bn. If just two per cent of the UK’s business loans were diverted towards P2P lenders, the sector would nearly double in size.
“The biggest barrier we face is awareness and it’s easy to see why,” says Marston. “Small business owners are used to going to banks for finance and the business finance market is less transparent than the consumer finance market.”
This is a challenge that P2P platforms must embrace if they are to take full advantage of the lucrative business lending market. There is no question that the loans are out there, but platforms need to work hard to prove that they can handle the extra capacity and offer a reliable service.
P2P lending only works when there is an equal balance of investors and borrowers. The investors are already there – time to start courting the businesses.