Is peer-to-peer lending the new saving?

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Nick Moules
14th August 2013

As interest rates look set to remain at a record low until employment figures recover, Nick Moules asks whether people waiting for savings to bounce back are waiting in vain.

Keen followers of the peer-to-peer lending industry will know the two main contributors to its rising popularity – the difficulty individuals and businesses experience securing reasonably priced credit and dire savings rates.

While credit could improve for businesses and individuals, the medium term prospect for savers looks bleak.

There are two types of savings, rainy day funds to cope with a broken boiler or a hefty car repair bill and long-term lifestyle supplements. While you might not expect a fantastic rate for rainy day funds, as access is probably more important than the rate, relying on a bank to give above-inflation interest on long-term savings is futile at present. In this instance it is the rate that’s important, so why has it not improved and what can people do about it?

Banks are encouraged to lend money at the moment through the Government’s decision to back a strong housing market (and incentivise the banks for doing so). Whatever your view on the policy and the moral obligations of the government to artificially prop it up, the move demonstrates a support for further debt in the economy ahead of prudence. Those who feel they are doing ‘the right and sensible thing’ by using retail savings accounts  feel persecuted for doing so, which must be confusing and frustrating.

The premise of savings has always been to provide banks with a funding line in return for interest. At the moment, the two are woefully out of sync and it is unlikely to improve any time soon. Savings rates have traditionally been linked to the Bank of England base rate, so that will either have to rise (which seems unlikely given Mark Carney’s recent announcement) or become tied to something else for savers to realise value – the rate of inflation would be the most beneficial as many savings accounts are currently ‘rewarding’ their owners by quickly reducing the real value of their money as inflation outstrips interest offered.

Or the responsibility for achieving a desired rate will have to change, from the bank to the individual.

This has been the preserve of so-called sophisticated investors in the past, but with such poor returns, there needs to be more free financial advice for ordinary folk about how to beat savings rates.

Lending to other individuals or businesses is one such option and could become the long-term trend.

Pensions are unlikely to offer value as they have done in the past. People live for longer, the Government is introducing gradual rises in the age at which someone can start drawing a state pension and final salary pensions are extremely rare. In short, money has to go further for longer with less help from employers.

Furthermore, the internet has brought a new efficiency to financial services. Lean outfits with low overheads can ensure the transfer of funds from one side to another quickly and responsibly. Online currency exchange through the likes of Transferwise offers startlingly good value when compared to the high street and this has spilled over into the peer-to-peer markets.

To get value from the cash being set aside in peer-to-peer lending, individuals need to establish their risk appetite. How much could they realistically afford to lose? What level of return would they be happy to achieve? If someone is clear in their mind and devises an appropriate lending strategy, they can comfortably outstrip returns offered through savings, even allowing for inevitable defaults.

As regulation for peer-to-peer lending approaches, there will be added protection for those investing in the industry. A powerful independent regulator will keep operators in line and although definitive regulations are still unclear, access to a compensation scheme (either the Financial Services Compensation Scheme or something similar) would remove the one safety net not currently applicable to peer-to-peer. Providing the regulation isn’t too overbearing, the efficiency which means businesses can get loans from 6% APR and lenders can achieve up to 20% returns should remain, generating real value and importantly, a long-term alternative to savings, which will no doubt still be languishing well below inflation.

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