By  IONA BAIN

 

Peer to peer finance is becoming a force to be reckoned with as a credible alternative to Britain’s banking system.

Few consumers have yet heard of this corner of the financial industry, let alone understand how it works.

But that could all change in April next year, when savers will be allowed to funnel their Isa allowance (currently £15,240) into this burgeoning market without paying any tax. Chancellor George Osborne announced the decision to include P2P finance within a new Innovative Finance Isa (IFI) in his Emergency Budget this month

That would further enhance the already impressive returns – between four and nine per cent – that are currently earned through peer-to-peer platforms, which take savers’ money and lend it out to borrowers and small businesses.

These online middlemen offer different rates of interest for lenders depending on the risk profile of the borrowers involved, but the biggest providers boast of extremely low default rates.

P2P already been enjoying a surge in popularity this year, with £507million worth of loans issued by the biggest platforms in the past three months alone. Data published by the P2P Finance Association earlier this month showed that lending has risen by around £48m from £459m in the first quarter of this year.

Much of the demand has been fuelled by pensioners desperately searching for income in a low interest environment. Lending Works recently revealed that the amount of capital coming into the platform from older investors has shot up by 35 per cent in the last three months, to 70 per cent overall, with over half of its lenders now aged over 55.

The largest platforms have also been beating banks and building societies when it comes to customer satisfaction. Ratesetter recently came top in a Which? poll assessing customer service across the whole financial sector, scoring 80 per cent among the consumer organisation’s 5000 members compared to the average 54 per cent achieved by traditional providers in a previous poll.

Ratesetter also outperformed even more established P2P lenders such as Zopa and Funding Circle, which scored a respective 67 and 62 per cent.

Banks and building societies are now starting to take notice. Santander now refers rejected business loan applicants to Funding Circle, which in turn promotes Santander’s business banking services. Royal Bank of Scotland struck a similar partnership with the same platform, as well as Assetz Capital, in January.

But Yorkshire Building Society, the UK’s second biggest mutual, is fighting back amid fears that a new three-way Isa could split their customers’ loyalty. Last week, the mutual published research saying that 62 per cent of financial advisers would never use P2P platforms themselves, with 82 per cent saying that customers “do not understand the rules” round P2P finance.

YBS expressed dismay that more than one in three investors are targeting returns of 6 per cent over five years, and one in eight are aiming for 8 per cent, without considering losses of capital or whether they might need early access to it.

P2P platforms are also not covered under the Financial Services Compensation Scheme, the government-sponsored safety net for our savings that kicks in should a provider go under. This could prove a barrier for the extremely risk-averse saver, though bigger platforms are quick to point out that they have been subject to the same kind of “stress tests” imposed on banks since the financial crisis.

Speaking at recent roundtable in London, Giles Andrews, founder of Zopa, said: “In 2008, yields only went down by 25 basis points (0.25 per cent), while bad debts increased by only 1 per cent. That meant our average yield only went down to 4.5 per cent, which is pretty remarkable and as an asset class we even outperformed the UK housing index.”

James Meekings, co-founder of Funding Circle, said stress tests indicated that its average returns would fall from 6.5 per cent to 5.5 per cent in a recession.

He added: “As the industry gets bigger, we can spread out money across more loans, which means safer risk profiles can be guaranteed. The bigger platforms will consolidate their business but the smaller platforms will have to take on riskier loans and offer higher interest rates just to survive.”

Christian Faes, partner at mortgage P2P provider LendInvest, indicated that home loans could be the next market to experience disruption. “When you look at the experience of mortgage borrowers, most have to wait three months for their loan to be approved.

"We can approve in two weeks, so we compete on speed in a substantial way. I cannot ever see a bank offer similarly competitive services when they are so far behind in their thinking and processes.”

Meanwhile the new Isa has been welcomed. Bruce Davis, co-founder of P2P ethical platform Abundance, said: “This new middle ground solution will help to encourage more money to be invested in productive assets rather than cash deposits that contribute virtually nothing to either savers’ personal finances or the productivity of the real UK economy.”