Jill Kerby

PEER TO PEER LENDING – WHERE RISK AND REWARD MAKES S€NSE

When will interest rates go up?  No time soon is the consensus view of EU economists and money-brokers who are think the ECB 0.15% interest rate could even drop to zero. 

This column has already looked at the consequences of such a lot rate: tracker mortgage holders end up at the top of the feeding chains as their loans fall in value with the ECB rate while at the bottom are savers who see their deposit returns collapse, and the ‘real return’ on their money depreciate after DIRT and inflation is taken into account.

Borrowers are also disadvantaged:  the banks, still trying to get their own balance sheets into positive territory, further tighten their lending conditions and hike up fees and charges.

Is it any wonder that savers, pensioners, unlucky variable rate home-owners and people running small businesses are finding so little solace in this “recovery”?

Last week I met Peter O’Mahony, the founder of Linked Finance (see www.linkedfinance.com) a company that has identified a market gap between the shortage of affordable lending to small business and the need of savers for an acceptable, risk-rated return on their savings.

Based on the eBay model that brings willing sellers and buyers together to an auction that determines the price of the good – a loan, in this case. The loans last for three years and the borrowers must be owners of small limited liability companies, sole traders or in partnerships. Their firms include the proverbial butcher, baker and candlemaker, all sorts of other, high tech and medical device companies, breweries and financial service providers.

About €4m of finance has been arranged so far, said O’Mahony and the average borrower has secured about €28,000 from an average of 189 lenders, each of them investing about €150. Each lender (6000 are registered, only 1000 are active) has lent to nine different borrowers.

“No single loan can be more than €2,000 – which means that lenders with larger sums must spread their risk.”

The on-line auction determines the interest rate at which the borrower secures his/her loan, with the lowest rate, the winning bid. “The average interest rate is 8.9% per annum.” he explained. “The equivalent unsecured loan from a bank – and all our loans are unsecured – would cost the borrower between 9.5% and 13%.” 

That 8.9% gross annual return (7.7% after Linked Finance take their fee) is far more than any saver will earn from a deposit account. But P2P lending comes with a very real risk that you could lose your capital if the company you’ve lent to defaults on their repayments or goes bust. 

It is early days, “but not a single borrower has missed a payment” claims O’Mahony.  “That will change,” he says, “but that’s why we have a €2,000 per loan limit and why lenders are encouraged to spread their loans.”

Peer to peer lending is coming into its own here and in the UK because of the shortage of lending from the banks, and the lengthy, tiresome hoops that they make small borrowers jump through “for relatively small amounts. Many of our owners tell us that given how much easier [Linked Finance] is they will never go back to the banks if they can avoid it.”

Linked Finance provides borrowers and lenders with both the on-line auction platform and the lender with a segregated account “into which they receive 36 monthly, amortised, direct debit payments of capital and interest”. They can either withdraw their monthly return or leave it there to compound, or lend on to another borrower, O’Mahony explains.

And while Linked Finance vet borrowers and post this information on the web-site and do credit checks, they don’t rank the borrowing companies performance or prospects – that risk determination has to be the lenders’ alone, says O’Mahony. 

But their experience is that many loans come from the borrower’s own community and they are encouraged to keep up that goodwill by offering their lenders product vouchers and discounts.

Peer to peer lending is not for anyone who is so risk averse that they need a capital guarantee (albeit one that will be eaten away by inflation.)  You should never invest any money that you have to live on.

Peer-to-peer lending is a remarkably simple, transparent concept. It hasn’t been hit - yet - by intrusive government regulation or levies yet that add layers of costs and complexity. The conventional banks don’t see it – yet – as a threat.

Until then, it may be worth checking it out for what it is:  a great idea that rewards a manageable level of risk.

If you have a personal finance question you would like answered, please write to Jill at jill@jillkerby.ie