For all the resilience the UK economy has shown, there is no doubt that this year's ISA season is set against a backdrop of uncertainty. Whatever the pros and cons, Brexit, and a lack of clarity on what our future economic relationship with the EU will look like, has left us at a crossroads.
How will an increase in Bank of England rates affect P2P lending?
With each passing day, savers are filled with hope that substantial and sustained increases to Bank of England (BoE) rates are on the cards. At the recent Monetary Policy Committee meeting in February, Governor Mark Carney stated that rates would need to rise ‘earlier’ and by a ‘somewhat greater extent’ than previously thought at November’s review. Since then, a number of members have broken ranks to strongly imply that the first of these will come in May, and that consumers can expect two further rate hikes in 2018.
By their nature, interest rate movements will not please everyone, and there will be some who may be alarmed by such hawkish language. But few people could begrudge long-suffering savers, who’ve had to endure record-low interest rates for almost a decade.
Yet one of the questions asked on many forums at the moment is with regard to peer-to-peer lending (P2P), and how the sector will be impacted if the Bank does follow through on these base rate increases.
How will peer-to-peer lending rates be affected by base rate hikes?
P2P platforms such as Lending Works do not actually set their loan rates and lender returns based on BoE rates. Instead, we use our own ‘base rate’ – one which fluctuates depending on the balance between the volume of lending capital coming in from our lenders, and the level of demand for loans from borrowers.
Although the algorithm behind it is not quite so simplistic, invariably a comparative excess in lender capital versus demand for loans leads to a decrease in our ‘base rate’ (and therefore lower loan rates and lender returns), and vice versa. As such, there is no component within this equilibrium which is directly affected by decisions taken on Threadneedle Street.
That said, there are ramifications which can have an indirect effect. As we saw in the wake of the rate cut that followed the EU referendum, lender returns decreased across the P2P sector. This was primarily as a result of a looser monetary policy, which in turn led to a more competitive market for loans. Therefore, loan providers – including peer-to-peer platforms – lowered their borrowing rates in order to keep pace, which in turn meant lower yields for lenders.
Furthermore, this drop in BoE rates piled further misery on savers, who quickly saw banks and building societies cut the already-derisory returns they were receiving. It is widely accepted that this led to a surge in demand among consumers for the superior returns available via peer-to-peer platforms - albeit that this increased supply of lender capital ultimately applied downward pressure on lender returns as a result.
In summary, based on these outcomes in H2 2016, it seems highly likely that the converse will eventuate if/when the Bank pulls the trigger on base rates: that is, the loan rates offered by P2P platforms will increase, while lenders will enjoy improved returns.
Will there be a rise in defaults within P2P?
Many people are concerned that higher base rates will mean a greater number of borrowers being unable to repay their loans, and thus result in losses for those who have lent money via peer-to-peer platforms. It’s a valid concern, but it must be pointed out that the APR at which individuals acquire a loan from a platform such as Lending Works is fixed. This means that, once you are locked into a loan contract with us, your monthly repayments will not go up - regardless of changes to either the BoE rate, or Lending Works’ own 'base rate'.
Yet the cost of other borrowing could still have an indirect impact on those who have taken out loans with a P2P platform. The most relevant example would be in relation to mortgages, which, despite enabling borrowers to fix their rates for a period of time, are ultimately variable-rate debts, and the increased cost of paying off one’s home could conceivably make it harder to concurrently pay off other unsecured loans.
So, will an increase in base rates be bad for peer-to-peer lending?
Increasing Bank of England rates isn’t uncharted territory for the P2P industry. The sector has been around since 2005, and, in the time between the launch of the first-ever platform and July 2007, the Bank hiked rates on five separate occasions (from 4.5 per cent to 5.75 per cent). In that two-year period there was little in the way of increased defaults, and even during the financial crisis that followed in 2008/09, defaults and losses were contained such that lenders still benefited from actual returns in excess of the rate of inflation.
It must also be borne into mind that a platform like Lending Works plans for the realities of the economic cycle every single day. There are numerous ways in which this can be demonstrated, but one transparent figure that reflects this is our overall bad debt coverage, which is published on our website and is regularly monitored to ensure the Lending Works Shield is always able to cover the estimated remaining losses for each loan cohort. This is managed partly by meticulous loan underwriting, but also by the fact that we set aside substantial provisions to cover expected losses on loan defaults – and that doesn’t even factor in the separate insurance we have in place as part of the Shield.
Thrive, not fear...
The above is not to deny the risks involved with peer-to-peer lending, and every person considering investing via platforms such as ours should be aware there is no FSCS cover, and that capital is at risk. However, rather than being fearful of a new era of higher interest rates, we embrace it. We value our borrowers and lenders equally, but it is our belief that, within the wider economy, the balance has been skewed against savers for far too long, and that a re-calibration is long overdue.
And within P2P, it is our expectation that consumer lenders can look forward to even higher rates of return, for the reasons articulated above. This may concern borrowers, given that banks have historically tended to pass on the burden of base rate increases to customers quickly and sharply. Yet that in itself provides an opportunity for the P2P sector, which functions more efficiently than high-street lenders. By offering a fair deal, and functioning independently from Bank of England rates, companies like ours can ensure customers aren’t forced to pay over the odds, and that the marketplace for loans remains competitive.
Rather than being an obstacle, this new dawn of higher base rates presents yet another opportunity for P2P lending to stake its claim within the mainstream of UK financial services. And, most importantly, as the sector continues to thrive, it is ordinary consumers who stand to reap the benefits.
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