Consumer lending is a cornerstone of peer-to-peer finance, but with fears of a personal debt crisis and fierce competition, should platforms be worried?
PEER-TO-PEER lending is a pretty diverse sector, with dozens of platforms out there offering everything from domestic loans of a few hundred quid at one end to full-blown commercial facilities of several million at the other. It attracts an equally diverse range of investors to fund those loans, ranging from retail money looking for better returns than a savings account to increasingly sophisticated institutions building substantial portfolios.
But one of the biggest divides remains the one between the platforms offering unsecured consumer loans, and those which operate in the small- and medium-sized enterprise (SME) space. So what are the characteristics of a consumer lender, and how do their models and operational priorities differ from platforms making business loans?
P2P has built its name on doing things better, faster and cheaper than traditional players, says Nick Harding, chief executive and founder of Lending Works, which means in turn that the quality and speed of the technology platform is especially significant for consumer lenders. “Tech is absolutely more important in consumer lending,” he asserts. “You have to operate at scale in consumer and to do that you really need good tech.”
Lending Works opened its doors in 2014 and has made just over 18,500 loans since, with an average loan size of £6,039, according to the platform’s statistics. It has sustained annual growth of over 100 per cent each year, and this year is running at 125 per cent to date, a hectic pace which, Harding says, it could not have achieved without fast and reliable automation of as much of the process as possible.
By comparison, SME loans tend to be substantially larger – the average loan size in 2018 for the largest SME platform Funding Circle is just over £65,000, down from a peak of £74,000 in 2016, according to data from P2P analysis firm Orca Money. And while – with loans of £3bn under its belt – you can hardly accuse Funding Circle of lacking scale or ambition, Harding’s point is that size is not so much of an existential factor for SME lending in general. Many smaller platforms in that market still provide a strong offer both to borrowers and investors whilst servicing a relatively modest number of loans.
The nature of competition in the consumer market also favours lenders whose balance on the fintech spectrum is more ‘tech’ than ‘fin’. “We are using APIs to connect, and to drive a slick customer journey,” says Harding. “Many mainstream banks are simply not interested in that, we have had categorical feedback from them on that point.” Perhaps at least partly because their well-known legacy tech issues (TSB anyone?) make it that much harder for the banks to engage on the same level, he adds.
The app-ification of so many of their daily needs also means that consumers increasingly demand Uber or Deliveroo-style speed and simplicity from their loan providers, too. “Consumer customers are really impatient and they just won’t wait,” explains Harding. “If you can say to your customers ‘Plug in your details and you’ll get a decision in two or three seconds’, that’s really powerful. But if you say ‘Someone will call you in 24 hours’ – well, maybe another lender will have said yes to them by then.”
Despite coming under the same catch-all P2P umbrella, there’s no doubt that consumer and SME lending are pretty distinct from one another, says Iain Niblock, co-founder and chief executive of Orca Money. “We are always saying that building a diverse portfolio across P2P is valuable, because SME and consumer loans are not closely correlated,” he comments.
The advantages of operating in the consumer space, he adds, are the size of the market, plus the fact that consumers tend to resemble each other more closely in terms of credit profiling than businesses do. “It’s a massive market, so there are huge opportunities especially if you can find the right partners,” he says. “And the majority of consumer lending is done off scorecards, so it’s about automation, there is less underwriting required than in business lending.”
But those potential rewards come with a few inherent challenges attached. “Funding Circle’s market share in SME lending is more than Zopa’s or Ratesetter’s in consumer,” he says. “There is less competition in business lending.” The main reason for that is that SME platforms face less competition from conventional lenders than those in the consumer market. “It costs a bank the same to write a £50,000 loan as it does to write a £3m loan,” Niblock adds.
Consequently, banks tend to focus on larger loans to more established businesses and leave the smaller end of the SME market to alternative players with lower cost bases.
That competition puts pressure both on margins for the platforms and returns for investors. “Consumer lenders are all fighting for super prime borrowers, and the competition has pushed down returns,” explains Niblock.
“On the business lending side they can afford a bigger spread. But at four per cent on a consumer loan, you have to give the lender a return on that and a margin for yourself – it can be challenging.”
It’s an issue which puts off some institutional investors which might otherwise be tempted to get into consumer platforms. “We are not against investing in consumer lenders in principle,” says Alison Harwood, senior vice president at Varengold Bank’s London office. “We see platforms with good credit discipline but the biggest challenge is seeing the yield.”
So despite backing P2P lenders including MarketInvoice and EstateGuru, Varengold has yet to put any money into a consumer platform. “Compared to, for instance, property-backed lending, there just isn’t the same yield at the safe consumer end of the market,” she adds.
The way to deal with lower margins is to have more customers, and one way in which P2P platforms do this is by offering loans through partners with access to large customer bases, such as mobile phone providers and financial comparison sites. Building such partnerships is now a key part of the growth strategy for most platforms.
But success is about smarts as well as size – making better and more nuanced credit decisions, according to Lending Works’ Harding. Consumers may be more alike than businesses, but there are still valuable distinctions to be uncovered if you know how to look. “The amount of data that we consume per customer is staggering, the checks are so much more sophisticated than they were even five years ago,” he reveals. “We do electronic income verification checks, affordability checks, fraud checks.”
That enables them to make better decisions, more quickly – but perhaps the biggest difference between a young and energetic start-up and an established traditional lender is one of attitude. Whereas a bank might get to a point where it is happy with its credit processes and leaves them be, the culture at businesses like Lending Works is about continuous improvement. “We are always looking to make our model better, and that never stops, we will be doing it forever,” affirms Harding.
He also refutes the idea that consumer lending is inherently less attractive to institutional investors than SME lending. “For every investor who says that, there is one who prefers consumer because SMEs are too volatile,” he asserts.
“We have institutions knocking out door down – we’re in well-developed discussions with four institutions and we have one live on the platform.”
One area where life is clearly more complicated for consumer lenders however is regulation. “Compared to SME lending, the consumer regulations are very strict on assessment and affordability, arrears handling and vulnerable customers,” says John Coley, director in the financial services risk regulatory practice at big four accountancy firm PwC.
Having taken over responsibility for consumer credit only four years ago, the Financial Conduct Authority (FCA) is very active in overseeing the sector. “The regulator is still sitting forward in its seat and consumer lending is very much under the spotlight,” he continues.
“A phrase used a lot by the regulator is ‘consumer harm’, and that can be more prevalent in consumer lending.”
An energetic regulator means plenty of changes to stay on top of. For example, the FCA is working, says Coley, on a new definition of vulnerable customers which will be based on making an assessment of people’s financial resilience – the more resilient, the less susceptible to harm. It’s also investigating the use of technology such as voice analytics to try and spot callers who might be confused, or have misunderstood what lenders are offering them. “Keeping up with the sheer volume of regulations can be a challenge,” says Coley.
The other factor that is never far away from any discussion about the prospects of consumer lending, is the UK’s rising level of debt. According to a report published by Coley’s PwC colleagues late last year, unsecured UK consumer debt grew at 11 per cent in 2017 to hit £300bn, some 30 per cent more than its pre-2008 crash peak. That’s an average of £11,000 of unsecured debt per household.
That’s a lot of debt. But for everyone who thinks it is too much, there are others for whom it’s simply the natural consequence of wider factors. “Why is debt rising? It’s the low interest rate environment,” says Orca’s Niblock. “The government is keen to encourage spending, and more lending means more money in circulation and more spending. So that’s a clear reason – interest rates are low and so the cost of debt is low.”
Lending Works’ Harding adds that no lender can afford to be complacent about the wider credit conditions. “There has been some commentary about inflated credit, and I never take commentary from trustworthy sources like the Bank of England or the regulator lightly,” he states.
But he also points out that the type of debt – and debtor – is important in assessing those conditions. “There’s always an immediate concern ‘Is this the start of the next cycle?’” he adds. “But it’s not as negative as it’s been painted – the flipside is that the regulator has also said that credit is growing in the right places, with prime borrowers who can afford to pay it back.”
After all, providing easier access to better products and services for customers and investors is what everyone in P2P wants, regardless of whether they are consumer or business lenders.
This article featured in the July edition of Peer2Peer Finance News, now available to read online.