In the years following the global financial crisis of 2007-2009, peer-to-peer lending was viewed as a fintech alternative to mainstream banking. The ability to directly connect borrowers with lenders via online platforms, cutting intermediary costs which allowed for higher deposit rates and lower borrowing rates was revolutionary.
In a market rich in falling interest rates, more and more yield-hungry investors turned to P2P lenders because of their accessibility and greater potential return on investment. In fact, from 2014-2019 the UK’s total volume alternative finance (60% of which is P2P lending is categorised under) rose from £547 million to £2 billion, according to Statista.
However, as with most every single sector in the UK, the Coronavirus pandemic and subsequent national lockdown disrupted lending.
The Spring of 2020
At the start of the year, things began to change. The political shockwaves and regulatory uncertainty that rippled across the sector in 2019 persisted. However, this did not stop the market reaching new heights.
Yet, the biggest disruption for a decade was yet to come. In the spring of 2020, the sector faced severe headwinds. As national lockdowns swept the globe, investors scrambled to withdraw their funds from P2P lending platforms.
For the first time in over a decade, a shadow was cast over the UK economy. At a time when investors were in desperate need of liquidity, some platforms froze withdrawals. Why? Platforms sought to protect themselves in various ways – RateSetter, the UK’s biggest P2P lender slashed its interest rates.
The Economic Fallout of COVID-19
For a sector that came into its own in the aftermath of the global financial crisis, the economic fallout of COVID-19 was eerily similar to what financial markets suffered in 2008. Although some of the principal causes of this most recent disruption mirrored what happened just over a decade ago, the problem was fundamentally a liquidity crisis.
What we mean by this is that investors sought to reduce their exposure to mortgage-backed securities – although global exposure to severe toxic assets was nowhere near the scale that it was during the global financial crisis.
However, let us not forget that in the immediate years following the global financial crisis, markets were anything but rosy. Slowly but surely economies started to rebound as the 2010’s evolved, but not without casualties.
For instance, Brexit prompted UK property funds to temporarily halt investor withdrawals in 2019. The uncertainty surrounding ongoing negotiations and the looming end to the transition period, formally set for 31st December 2020, not to mention that trade agreement tariffs and regulatory barriers that are yet to be confirmed have all contributed to a disruption in P2P lending.
Now, although these are separate problems, both Brexit and COVID-19 represent challenges to peer-to-peer lending. Illiquid investments (the state of a stock, bond, or any other assets that cannot be easily sold or exchanged for cash without a significant loss in value) have caused a problem because liquidity was and still is needed.
What the Future May Bring
Now, you may be forgiven for believing that it’s all doom and gloom. However, this is not the case. Peer-to peer-platforms that ride out the disruption will emerge more resilient than ever before. This represents an opportunity for such platforms to gain market share and set themselves apart from the competition.
However, this isn’t without its own complications. The sector will need to provide assurance to investors. Why? Being cut off from funds is something that no investor wants, even if they end up losing little to no money.
What’s clear to any industry insider is that faith in peer-to-peer platforms is not as strong as it was a year ago. The good news is that there are three lessons that we can learn from the economic fallout of COVID-19.
Sound Investment Product Structure to Reduce Liquidity Risk Is Needed
Investment products are structured according to close-ended funds quoted on the stock exchange. When investors want their money back, they sell their stake in the fund to someone else. This enables the investment manager to hold illiquid assets (for example, unlisted shares or property) without the risk of having to liquidate these assets when investors want their money back.
This may not be applicable to P2P lending. However, there are ways that liquidity risk can be managed. For example, a percentage withdrawal fee can be placed on untimely withdrawals. This discourages investors from withdrawing their funds before the loan matures.
P2P Lenders Must Consider the Kinds of Investors they Want
What we did see this year is P2P investors withdrawing their assets, whilst keeping their stock portfolio. This created the impression that P2P investments were not considered to be as ‘safe’ as other types of investment.
Making sure that investment expectations are managed by operating a transparent policy, even warning investors of capital losses is clearly shrewd – and necessary – commercial practice. Peer-to-peer platforms should be open with their customers, even telling them that some setbacks and a temporary loss of liquidity is, depending on the economic circumstances – to be expected.
Build Investor Trust
Customer service is one thing. Personalised customer experience is another. The P2P sector should focus on building personalised customer experiences.
COVID-19 and local lockdowns have proven disastrous for small, local businesses. With people growing more and more aware of this, there has been a growing consensus that supporting local businesses is something we all should be doing. This presents an opportunity for the P2P sector to play a vital role in supporting UK-wide economic revival.
This can be done in several ways. For example, better, more accurate data could be shared. Why is this important? Promoting transparency will reduce uncertainty and therefore increase consumer trust.
What We Should Remember
COVID-19 will not be the last disruption to affect the P2P sector. What is most important to remember is that the nature of the disruption is not important. It’s how we deal with it. Lessons learned will be vital in avoiding future problems.
History tends to repeat itself. Peer-to-peer platforms that learn the lessons of COVID-19 promote future stability. Adaptive platforms are the way forward in 2021 and beyond.
Interested in learning more about how COVID-19 has impacted peer-to-peer lending? Get in touch with Northern Provident today on 02896 001616.