Disruptive finance

The financial services industry is being turned upside down by innovative businesses that are changing the way we borrow, lend, invest and move money. Iwona Tokc-Wilde provides a low-down on the alternative finance revolution

The global economic crisis has led people to question traditional banking systems and finance models. It has also led to traditional trade finance, credit and loans being less accessible. In the meantime, evolving internet technologies have made it easier for people to deal directly with one another, cutting out the banks and other financial intermediaries.

On cue, a whole host of new companies have emerged which, by combining accessible finance with technology, now offer alternative solutions for loans, investments and foreign exchange services.

Alternative finance covers a variety of new financing models, which connect people seeking funds directly with funders, usually via online platforms.

‘It includes peer-to-peer (P2P) lending and crowdfunding,’ explains James Sears, senior tutor in entrepreneurship and innovation at Surrey Business School.

P2P lending is used for personal and business loans, while crowdfunding is typically for specific projects or ideas where investors do not get interest but instead receive rewards (for example, they may get the first release of an album or the product they have donated to) or, since recently, equity or shares in the new venture.

‘Kickstarter, the most recognisable name in crowdfunding, was launched in 2009. Today the industry has mushroomed into hundreds of different platforms worldwide whose purpose has evolved from donation/reward-based funding to equity, peer-to-peer and real-estate based funding,’ says Sears.

Online P2P lending platforms, such as Zopa in the UK and Lending Club in the US, were one of the earliest disruptors in the lending market, allowing individuals to borrow directly from, or lend money to, other individuals. They undercut consumer loans and personal savings providers so, in return for a small fee, lenders get a better rate of return on their investment, and the borrowers pay lower interest on their loan than a bank would offer. Lending Club has so far funded over $6.2bn of loans and paid out over $595m in interest to investors.

Lending Club also offers low-cost business loans of up to $300,000. In the UK, businesses can borrow via platforms such as rebuildingsociety.com (up to £300,000), Funding Circle (up to £1m) and ThinCats (up to £3m). ThinCats expect to reach £1bn total loans soon, and no wonder – the alternative finance market is massive and growing.

Research from Nesta shows that, in the UK alone, peer-to-peer business and consumer lending, equity-based crowdfunding and other forms of alternative finance will reach £4.4bn in 2015. In the US, P2P platforms are expected to facilitate $1trn in business and personal loans by 2025, according to Lending Club’s backer Foundation Capital.

But China is by far the biggest P2P lending market in the world. Although the exact number of lenders is unknown, P2P lending company Wangdaizhijia estimated there were nearly 1,200 of them in June 2014, with total loans outstanding of 81.8bn yuan ($13.3bn), up from approximately 800 lenders at the end of 2013. At the end of 2014, nearly 2,000 lenders in total were reported, with total loans outstanding of $22bn.

Fraud risk

However, P2P lending in China is unregulated so in some cases it is just a front for scammers. According to Wangdaizhijia, users reported problems with 275 separate P2P platforms in 2014. Chinese media is rife with reports of mismanagement and allegations of fraud, with some P2P lenders abruptly closing up shop and vanishing with investors' money, sometimes on the day they opened for business. The China Banking Regulatory Commission is currently researching how to regulate P2P lending.

Elsewhere in the world people are also starting to see the appeal of P2P lending and other financial businesses based on this model.

‘We’ve recently launched ThinCats Australia, and ThinCats Poland will follow soon,’ says Kevin Caley, managing director of ThinCats.

In India, P2P lending is still relatively new, with the main lending platforms I-lend and Faircent opening in the last two years and for personal loans only. Legal complexities and lenders bearing high risk of defaults mean that it may take a while for the social lending model to become more popular. Social impact investing, on the other hand, has been promoted in India for a few years now, by crowdfunding platforms such as Bangalore-based MicroGraam. It promotes development and growth throughout India by allowing people to lend to the poorer populations in rural areas while earning nominal returns.

The UK is also a global leader in social impact investing, says Jonathan Hick, analyst at ClearlySo, which helps social businesses and enterprises raise capital by connecting them with potential investors.

‘People are increasingly looking to ‘do good’ with their money,’ says Hick. ‘Now they can shape the world they live in through impact investing, whether through crowdfunding, community share issues or retail investing in shares and bonds,’ he adds.

What does the future hold for P2P lending?

‘It has the potential to facilitate more cross-border trade,’ says Nick Moules, marketing and communications manager at rebuildingsociety.com. ‘Legislation is catching up to allow individuals to lend to and invest in businesses outside their own country, but the technology and services [allowing cost-effective money transfers overseas] already exist,’ he explains.

Take TransferWise, for example. This P2P network uses sophisticated software to help consumers transfer money between countries at a cost of up to 10 times lower than what a bank would charge.

Are the mainstream banks and other major financial institutions worried by P2P? Perhaps not much, or at least not yet. They have not been developing their own copycat online operations and they are not buying P2P lenders out before they get too big.

‘But hedge funds, pension funds and even some banks are now taking the industry very seriously, which was confirmed when Lending Club raised over $9bn by floating on the New York Stock Exchange last December,’ says Kevin Caley of ThinCats.

In the UK, traditional lenders are starting to partner with the disruptors, too. Santander and the Royal Bank of Scotland now refer their small business customers to Funding Circle if they are turned down for loans by the banks.

Instead of trying to copy or assimilate the P2P trend, mainstream lenders are investing in and applying new, sophisticated technologies, to better serve their customers, and to avoid risky borrowers at the same time.

"People are increasingly looking to ‘do good’ with their money. Now they can shape the world they live in through impact investing, whether through crowdfunding, community share issues or retail investing in shares and bonds"

Jonathan Hick - ClearlySo