Lord Adair Turner looms large over the peer-to-peer lending industry.
The former banking regulator, who led the Financial Services Authority from 2008 to 2013, recently slammed the nascent industry, telling the BBC that: “The losses on peer-to-peer lending which will emerge within the next five to ten years will make the worst bankers look like absolute lending geniuses.”
Peer-to-peer lenders are online platforms that let savers lend their money directly to people and small businesses looking for cash. This gives savers and investors access to bigger returns than offered by banks and helps businesses and borrowers get access to cash.
But Lord Turner is concerned that automating the credit underwriting process will lead to more lax lending. He’s also concerned that investors don’t understand the risks associated with these loans and could be investing money they can’t afford to lose, something that could prove disastrous to the economy if the sector grows substantially.
The peer-to-peer industry reacted angrily to Lord Turner’s comments at the time, claiming their underwriting standards are as good as, if not better than, the banks. But the criticism has proved sticky and, at the AltFi Europe conference in London on Tuesday, the industry is still addressing the concerns.
Samir Desai, CEO and co-founder of the UK’s highest-profile peer-to-peer lender Funding Circle, told the crowd: “I don’t agree with some of the credit assessment stuff and I think many platforms have invited Lord Turner in to view our processes, reassure him, because I think it is important that we tackle this criticism head-on rather than just shout him down.”
But Desai admits that there is still one big question asked of the industry that it can’t yer answer. He said: “I think the stuff around the recession is obvious the thing that we talk about a lot internally, we model to, we try and create buffers for. That is clearly the most pertinent question that anyone can ask about our industry.”
Most of the UK and Europe’s peer-to-peer lending industry was created in the crucible of the financial crisis — Funding Circle was set up in 2009 for instance. Only Zopa, founded in 2005, has been through a recession. It fared well — average loan losses were 2.3% but average yield was 5.9%.
But while Zopa was OK, that doesn’t mean the rest of the industry will fare the same in another downturn — there’s a lot of variety between business models and risk assessment procedures.
Desai said: “We can never fully answer it because we haven’t gone through a downturn. All we can do is do similar analysis to Moody’s etc., we can do stress tests on our portfolio.
“If we do survive through a downturn, it probably means that we’ve delivered significantly superior returns to our investors and then that means the last remaining criticism of this industry goes away. The honest answer is we don’t know but we’ve been very prudent and we’ve done our best to model what happens.”
Cormac Leech, an analyst who covers fintech and online lending at boutique investment bank Liberum, has said in the past that even under “fairly aggressive” stress testing Funding Circle’s yields are likely to stay at or above zero. In other words, you’re unlikely to lose money. But until it actually happens, all this is just a thought experiment.
‘The hype year is definitely over’
Desai admitted that:”There’s been a lot of negativity around the industry recently and sure we have these short-term challenges. It’s going to be hard work but the kind of hype phase or hype year is definitely over.”
Desai highlighted a recent $7 billion peer-to-peer Ponzi scheme in China and the collapse of Swedish platform TrustBuddy as two incidents that have heaped greater scrutiny and pressure on the sector, saying: “Definitely, there’s more pressure on our industry.”
But Desai said: “My view is that, when you take a step back, in the medium to long-term prospects for the industry are better than ever.
“When we started Funding Circle in the UK — we quit our jobs around 2009 — we thought there was a compelling customer opportunity but we also thought there were a number of macro-factors that made this business model really attractive.
“We thought that interest rates would stay low for a long while. We thought we were in a Japan-style lost decade — a lost 20 years now — and that even when interest rates rose, they wouldn’t rise to sky-high levels. Whilst our business model works when interest rates rise, it’s a hell of a lot easier building this business when they’re so low.
“Not all of us are going to make it through this period. Marketplace lending is a scale business. You need to be doing hundreds of millions and then billions of dollars of loans to get the data to make this work. But I think the businesses that emerge through this period will be much stronger and much more resilient and usher in this golden age.”