3rd April 2014
With the average Isa paying just 1.65%, it’s not surprising that a number of savers are turning to the alternative finance market for higher returns writes Kara Gammell.
The UK’s peer-to-peer lending industry is developing at a rapid rate as more savers and borrowers move away from banks. With Financial Conduct Authority (FCA) regulation having come into effect on April 1st and Isa inclusion announced in the last month’s Budget, the peer-to-peer industry is set to see a surge of new consumers and funding to accelerate this growth.
So what is peer-to-peer lending and what does it mean for savers? Can this industry make up for the paltry returns offered by the banks and building societies?
Peer-to-peer lending platforms link those with cash to spare with those wanting to borrow money. Because it bypasses the banks, lenders can often get a better return on their money than with a traditional savings account, while creditworthy borrowers can access finance at a lower rate of interest.
The websites, which include Zopa, RateSetter and Funding Circle, have become increasingly popular since Base Rate fell to 0.5% because they offer returns of as much as 6%.
The industry is growing quickly in the UK, with figures from the P2P Finance Assocation estimating that the size of the lending market to both consumers and business stands at £600 million. But even this growth cannot disguise the fact that peer-to-peer platforms account for only 2% of the UK lending market.
But from this week, all peer-to-peer platforms will have to put strict systems in place, which will be overseen by the FCA. So will these new rules provide savers with the confidence they need to hand over their hard-earned cash?
Jafar Hassan, personal finance expert at uSwitch.com says: “The introduction of regulation should offer consumers more protection from issues such as borrowers defaulting on loan repayments. It will also provide a clearer understanding of the market and, most importantly, provide extra reassurance for consumers looking to make a return on their savings.”
However, Mr Hassan says that in order to encourage more widespread adoption, peer-to-peer lenders need to convince consumers that their money is safe.
“Providers can’t just rely on regulation to do this, consumers need to see how this industry can work for them with minimal risk,” he says.
Rhydian Lewis, CEO at RateSetter, agrees. He said that while he believed that the new FCA regulation would lend the industry the legitimacy it needed to break into the mainstream, providers had to do more.
“We cannot lose sight of the fact that security is the most important issue underlying the peer-to-peer sector,” he said. “Regulation is a welcome, solid foundation, but peer-to-peer players must now focus on the protection that they offer customers. Without this, the sector will never be wholeheartedly welcomed by UK savers.”
Under the new rules, peer-to-peer platforms must be completely transparent about charges, default rates and taxation and will not be able to advertise their services as ‘risk free’.
They will be required to implement strict systems which ring-fences deposits from the company’s finances, so should it encounter problems, savers investments are protected. These firms will also be required to have a third party arranged to take over if the platform goes bust. It has also been stipulated that this must be a seamless process so the investors are not inconvenienced in the takeover.
Under the new system, investors will be able to take any complaints to the financial services ombudsman and will be entitled to a 14-day cooling off period.
Yet, while the industry and consumer will welcome these new regulations, it is crucial that savers do not get lulled into a false sense of security by regulation – despite their similarities, peer-to-peer lending is still very much an investment, rather than savings product.
“Bear in mind that returns are not guaranteed, so as with any investment, consumers must consider the level of risk involved before choosing to invest,” warns Mr Hassan.
“Also, remember that no interest is paid while your cash is waiting to be lent out. While small amounts will be lent out quickly, it could take several weeks for larger lump sums.”
It is also important for prospective lenders to understand that there is no statutory safety net to protect their money should a site go bust. While the government-backed Financial Services Compensation Scheme (FSCS) guarantees deposits in authorised banks or building societies up to £85,000 per person, it does not offer any coverage for those who invest their cash through peer-to-peer lenders.
As with any financial decision, it is crucial that you do your research in advance and check which platforms are regulated before investing. All consumer credit in the UK is licensed by the Office of Fair Trading, and each peer-to-peer lender should show their Consumer Credit Licence number on their website. At the same time most reputable financial services businesses are members of CIFAS, the UK’s fraud watchdog. If the peer-to-peer operator you choose is not a member of CIFAS, it will not be able to check if a potential borrower has been reported as potentially fraudulent. It is also sensible to opt for a provider that is a member of the industry body the P2P Finance Association who set the standards for the industry.
Brian Dennehy of Fund Expert warns that even with the new regulations peer-to-peer lending is not a direct replacement for a savings policy.
“It is clearly high risk,” he says. “This is an industry which is relatively young with a limited track record. The risk is as with retail corporate bonds – very few investors have the skills to understand the risks, so great care will be needed with regulation before it is allowed.”
He adds: “What no one has really spotted is that by blurring the lines between cash and other Isa investments, the government is creating considerable scope for confusion as these sorts of higher risk products are sold on yield rather than risk.”