What would another recession mean for peer-to-peer lending?
The effects of the recession
Sceptics are quick to point out that for P2P lenders, the timing was perfect. The industry flourished at the back end of a significant recession, with two factors helping it:
Banks weren’t willing to lend to small businesses and property developers
At the same time, banks were paying very low rates to savers
It’s also fair to say that public frustration at banks helped too. As a result, both borrowers and lenders flocked to P2P lenders, as linking the two directly helped to solve both problems simultaneously.
Peer-to-peer lending in a recession
However, P2P lending is older than you might think. People lending to other people and businesses without banks goes back thousands of years at the very least – the ancient Greeks and Romans lent directly, and there are even references to it in the old Testament.
In modern times, the world’s first P2P lender - Zopa - launched in 2005 and successfully traded through one of the most serious recessions, and almost without incident. So while a recession certainly makes for difficult trading conditions, there’s no inherent reason why it would put P2P lenders out of business.
Another thing to consider is that platforms like Assetz Capital only issue secured loans, which are mostly property-backed and based on loan to value ratios which are modest compared to the price falls seen in the worst recession in recent memory. Platforms that take tangible security on loans can use that security to attempt to recover lender funds in the event of a default.
In simple terms, a recession means that the economy stops growing and starts to shrink and as a result, businesses stop looking for money to grow. However, once a recession peaks, businesses start to expand again and therefore need money to fund that growth.
There’s an important difference between P2P lending and banking which comes into play here.
How is P2P lending different from banking?
P2P lenders use a ‘one pound in, one pound out’ model, which essentially means they can only lend out what you invest. A bank, on the other hand, benefits from what’s called leverage. Banks effectively have a ‘Banking Licence’ to print money, and that means that they can attempt to increase their profits by lending, say, £5 or £10 for every £1 of capital they have in simple terms.
As a result, if loans start to default, banks can be affected more seriously than P2P lenders. Broadly speaking, they’re currently only required to keep three per cent of their outstanding loan book as capital (although this is under review, and may increase later this decade). Essentially, for every £100 lent out, they only need to keep a minimum of £3 in reserve. As the last recession showed us, if losses deplete this reserve then a bank goes bust and either stops trading or needs bailing out.
Banking in a recession
What we found in the last recession is that banks reacted strongly when they suffered from limited losses because of how much they had at stake and how little capital they had to provide against losses. Their response seems to have been to overcompensate by cutting back on lending.
It’s also true that SME loans are less cost-effective than larger loans for banks as, for example, a single £1m loan requires much less work to set up than ten £100k loans.
Together, these two factors meant that when the economy started to recover and businesses needed funding to grow, banks weren’t in a position to give SMEs as much help as they needed.
Back to P2P Lending
There is little danger of secured P2P lenders overcompensating in the way that banks did: they wouldn’t be left smarting after a recession as they’re not exposed to leveraged losses in the same way that banks are. Lenders would therefore be better able to ride out the economic storm and not be forced into a fire-sale of their investments as easily. For borrowers who continue trading, the interest payments to lenders would continue and for those that don’t there would be robust security that could be held by lenders until better times for hopefully full recovery of their capital.
P2P lending would follow the real economic cycle much more closely than banks so, once businesses were in a position to borrow for growth, investors would be ready to fund it and earn a healthy return in the process, albeit at a higher risk-adjusted interest rate than in the good times.
If there was to be another recession there would naturally be a fall in lending as it is human nature to reduce investments when the outlook is bad. However, as soon as the business environment picks up and SMEs start looking for funding for growth (typically, one year in), lending would begin again in earnest - probably long before banks re-enter the lending fray.
If you are interested in becoming a lender or a borrower, contact Assetz Capital today or call us on 0207 870 1023.
- October 17, 2014