Crowdfunding isn't always the answer
It’s vital that the government "isn’t blinkered or blinded by the excitement" around crowdfunding and recognises the need to support the ethical finance industry, argues CEO of Responsible Finance Ben Hughes.
It sounds like a helpful solution for a business needing to borrow: arrange a loan at an affordable rate from a group of individuals through a crowdfunding lending marketplace.
And with the huge growth in peer to peer (P2P) lending through crowdfunding platforms – it's predicted to reach £5bn in the UK by 2016 – many businesses are embracing this route. Analysts have even described P2P lending as “transforming” or “reinventing” banking.
But growth brings its own problems and popularity is certainly not always a good indicator of quality – or of fitness for purpose. And whilst many may argue about the need to reinvent the banking sector, there are plenty of responsible and ethical lenders already doing just that.
It's easy to be dazzled by "shiny object" syndrome: peer-to-peer crowdfunding platforms, combining finance and new technology, are players in the buzzing “Fintech” world. They look alluring to investors happy with exposure to risk. They are set to become still more popular since the Chancellor announced the Innovative Finance Isa, which will allow peer-to-peer investments to be held in the tax-free wrapper, from April 2016. And they do work for many investors and businesses. But not for all.
So, is the rise in peer-to-peer lending sustainable?
Any new and high growth sector, as it consolidates, is likely to have its share of market failure. Before criticising, we need to acknowledge the success of P2P lending, and the ways some customers are using it as part of a blended finance model to secure the investment or working capital they need.
But we shouldn’t flinch from looking at problems and learning from them, and from questioning whether the “emperor’s new clothes” are the right fit. Indeed, even industry insiders have doubts. Neil Faulkner of 4thWay, a peer-to-peer lending comparison site, told the Financial Times that “none of the P2P lending websites are fully transparent with lenders about their costs”.
This lack of transparency coupled with still limited regulation is problematic for borrowers and investors alike.
We must accept that peer to peer lending (and crowdfunding generally) is simply not the right option for many business borrowers
Poor governance can also be an issue. The recent collapse of P2P platform Trustbuddy left investors, whose money was being used to finance bad debts, exposed and facing the loss of all of their capital.
Understanding of risk is a concern too. Investors need to recognise that the tax advantage of the new P2P ISA does not bring the safety net they may be used to from existing ISA choices. The P2P ISA won’t be covered by Financial Services Compensation Scheme protection. And access to investors’ money could be difficult if they need it earlier than anticipated.
We must accept that peer to peer lending (and crowdfunding generally) is simply not the right option for many business borrowers. It may work wonderfully for high-tech, fast growth businesses, but many of these would have been able to access bank finance anyway.
Where crowdfunding falls down is at the riskier end of the market, the solopreneurs just starting out who need finance, but also need support, and the unsexy businesses without security or track record.
As Responsible Finance recently highlighted in a letter to the Chancellor, every day businesses are being declined bank loans as they don’t meet the requirements of a bank’s algorithm.
This is where responsible lenders play a key role with a model that enables them to take greater risks on entrepreneurs and businesses that have solid business plans but limited track record or security.
Responsible lenders are supporting the small businesses that are the backbone of the economy – our new report shows that this year alone they have helped 11,500 businesses to start and grow, creating 25,000 new jobs. The ethical loans market has experienced a rapid rise in the past 12 months with a 45% rise in lending to small businesses, social enterprises and local communities.
Crucially, responsible lenders offer more than just money: a relationship with the businesses they lend to as they create opportunities, boost enterprise and support growth.
So it’s vital that the Government, whilst rightly considering how P2P lending fits within the lending landscape, isn’t blinkered or blinded by the excitement of a 'shiny new thing'. By supporting the ethical finance industry the government and others can ensure that small businesses and start-ups continue to get the support and finance they need.
Photo credit: Eric Breetoe