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Peer-to-peer business lending - new ways of bridging the funding gap2nd of November 2012
The banks – who needs them? That’s a question some high-profile economists are seriously beginning to ask as alternative sources of finance come online to bridge the funding gap. Hartley Milner reports on one of these enterprising new kids on the block, the peer-to-peer business lender.
Frustratingly for us all, the bankers have drawn in their purse strings still further in defiance of calls for them to release the funding businesses desperately need for their own growth and to help lift Europe out of the doldrums.
A survey by the European Central Bank in the final quarter of last year showed a surge in the number of commercial banks that were becoming increasingly choosy about which businesses they were willing to finance.
Of those sampled, 35 per cent said they were applying stricter criteria to business loans compared with 16 per cent in the previous quarter. And new figures show this trend continued into the first half of 2012, accompanied by spiralling loan charges and increasingly draconian demands for security against default.
The banks’ riposte was to point to their own difficulties raising capital and pressure from regulators to reduce risk.
Peer-to-peer lending websites have been springing up across Europe on the backs of the banks’ penurious policies. Some serve the needs of private individuals and others loan exclusively to small and medium-sized businesses. Both types work much like eBay, putting investors directly in touch with borrowers. If all goes to plan, borrowers get the low-cost loans they want and lenders reap a better return on their money.
Business lending sites offer favourable terms such as no early repayment fees and your application may be accepted even when your bank has turned you down. Crucially, if you are unsuccessful in your application it will not affect your credit rating.
Since launching two years ago, UK website Funding Circle has arranged loans totalling almost 60 million euros to 1,039 businesses.
“We are an online marketplace, bringing together growing businesses needing finance and investors looking to gain a better return on their money,” explained Funding Circle’s David de Koning. “Currently, you have to be a company that has at least two years of trading accounts as a limited business posted at Companies House and there are a number of credit criteria that need to be met as well.
“The businesses we deal with have been trading on average for 15 years and are typically looking for around 72,000 euros, though you can apply to borrow between 6,000 euros and 620,000 euros. Borrowers range from the retailer needing to purchase additional stock because it has a new line coming out to the traditional cleaning company which has won a new contract and needs to stock up, or perhaps move to new premises. What they may have in common is that they have experienced difficulties getting finance from the banks because this source of loans has largely dried up.”
Loans with Funding Circle are offered over one, three and five years. They comprise unsecured and secured loans and large asset finance. The level of security required depends on the loan value and its purpose and may include a personal guarantee.
Businesses file an application on the website – the process takes around half an hour – and those that are successful are then scrutinised by a credit assessment team using some of the tests employed by traditional lending institutions.
Approved applicants are given a risk band from good to excellent and then post their loan request on the site’s marketplace. Here, investors choose which type of company to invest in and bid the amount of money they want to lend, plus the interest rate they would like to earn.
To spread their risk, each investor lends small amounts to lots of different businesses, so hundreds of individuals fund each business’s loan. Only the lowest interest rate bids are accepted, meaning the borrower gets the best rate possible. The site manages the collection of monthly repayments back to the investors.
In the case of an unsecured loan, once you have accepted it the funds will be transferred to your account. For secured loans and large asset financing, Funding Circle will set up the necessary agreements and arrange for the funds to be paid to you (for a secured loan) or for asset finance it will take care of payment to your supplier.
Interest rates average out at between 7.1 and 9.4 per cent across the four risk bands, with investors scooping an average gross return of 9.1 per cent. Businesses can keep their loan request live on the marketplace for up to 14 days in the hope the rate will come down as more investors enter the bidding process.
Time can be critical
“With us, it takes on average 12 days for a business to obtain access to finance against anything up to three months with the banks simply to get a decision on a loan request,” said de Koning. “For a company that is growing or looking to buy stock or staff up for a new contract, time can be critical and any delays can have adverse effects on their business. We don’t have the infrastructure of the banks and we are quicker and more efficient.”
Funding Circle makes its money by charging investors a one per cent annual fee on the amount outstanding on each loan part and borrowers two to four per cent, depending on the period of the loan.
UK firm Vanguard Cleaning turned to Funding Circle earlier this year to borrow 37,000 euros over three years to take on a new staff member following a number of contract coups. The medical cleaning specialist had a loan application accepted by its bank but found the terms unpalatable.
Managing director James Crompton said: “The interest rate the bank wanted to charge was quite high (6.5 per cent). But the main thing that put me off was that they wanted to secure it entirely against my personal assets – namely my house, which I regarded as unreasonable.
“The appeal of Funding Circle was the ease and speed of the process, the fact that no security was required (other than a standard director’s guarantee) and the competitive interest rates. I also just liked the idea of bypassing the banks because I object to some of the things they do.
“The whole process took around 14 days. We were pledged 37,000 euros by around 200 potential investors pretty early, but we let the process run to allow more people to bid in order to reduce the final interest rate we would have to pay, displacing the people who were asking for a higher rate. The final figure was about seven per cent, but the deal-breaker was not having to put up the personal security.”
Crompton added: “In many ways, our bank offers a service we would not want to be without, in terms of making internet payments to our staff etc. But I think borrowing is not going to be something we will automatically go to a bank for in future. If we need to raise funds, we will definitely consider going to a peer-to-peer lending site again.”
So what are the risks? Borrowers get the competitive loan they crave, but the flip-side for investors is that peer-to-peer lending is largely unregulated in Europe, meaning they risk losing some, if not all, of their money with no hope of compensation should the business – or the website itself – go bust. Funding Circle claims a bad debt rate of just 0.9 per cent, compared to around three per cent for the banks. However the site accepts that as it grows defaults are likely
“Regulation is something we would welcome,” said de Koning. “We have had conversations with the UK government about this over the last few years and were told that currently the industry does not require regulation. We hope that as the industry grows this will change and they will regulate us.”
Build industry confidence
Meanwhile, Funding Circle has linked up with other UK lending sites to go down the self-regulatory path, setting up the Peer2Peer Finance Association. It aims to build confidence in the industry as a secure source of loans and its members have pledged to conduct themselves in a manner as though they were regulated.
And the industry has received a nod from an unlikely source. Andrew Haldane, executive director for financial stability at the Bank of England, recently described peer-to-peer lending as a “very exciting development” and “one of the most interesting things I have seen in finance for many years”.
In a speech calling for the world’s financial institutions to adopt a common language so that financial risks can be mapped and understood, Haldane said such a move could allow a range of new business models to develop.
He argued that peer-to-peer lending through online sites could start to replace old-fashioned banking, adding: “With open access to borrower information, held centrally and virtually, there is no reason why end-savers and end-investors cannot connect directly. The banking middlemen may, in time, become the surplus links in the chain.”