By: Michelle Stephens
Financial institutions play a critical role in supporting the survivability, growth and sustainability of small and medium-sized enterprises (SMEs) through investments, savings and lending services. SMEs argue that this role is undeveloped and credit financing is largely inaccessible. They further argue that this inaccessibility is due in part to the slow approach to innovation by the traditional financing sector, its cultural inflexibility to use substitute client data for loan applications, capability limitations in responding to new industries (e.g. creative and green industries), and overall risk management policies to conform to the regulatory environment.
In 2016, the Caribbean Development Bank (CDB) reported that SMEs contributed 50% to the regional gross domestic product. Given the recognised importance of SMEs to individual economies, a relatively new solution called ‘peer-to-peer’ (P2P) or marketplace lending has emerged to address the accessibility gap in financing for small and medium-sized enterprises. According to the 2016 ‘Americas Alternative Finance Benchmarking Report’ by the Cambridge Centre for Alternative Finance, the online alternative finance market within Latin America and the Caribbean accounted for US$72.88 million or 66% of the total alternative finance transaction volume, a 97% growth rate between 2014 and 2015 driven by business finance.
So is P2P lending right for your business? Let’s have a look.
How It Works P2P lending is an online platform that enables lenders and borrowers to exchange investment and credit financing goals outside of the traditional banking system. It focuses on loans or bundles of loans, and earns revenue via fees and commissions from borrowers and lenders. P2P lending has its origin in the United Kingdom (UK) with the launch of the Zopa platform, and has developed alongside the rapid diffusion of technology, rising consumer trust in online transactions and appetite for immediacy, as well as the proliferation of public (online) data.
P2P lending may be more suitable for established SMEs with a trading history that are looking to grow, since the borrower will need to provide basic company and financial details, together with the reason for the loan, the amount and term. The P2P platform will then conduct a ‘soft credit search’ to determine a credit score and estimate the monthly loan rate. If the borrower accepts the rate, individualised fees and repayment protocols, the funds will be made available online within a few hours or days. On the other hand, the investor will identify their ideal investment return by specifying the maturity period or their risk profile or a combination of the two. Once approved the investor submits their investment, an interactive dashboard allows them to manage their activity.
How Does It Differ? Traditional banks intermediate between savers and borrowers, earning income by managing spread between the interest charged on loans and that paid on savings. The P2P lender matches lenders with borrowers via an online platform and makes money from commissions and fees from each respectively. They focus on loans and do not hold capital (from savings).
Bank depositors have no control over how their savings are used, but P2P lenders disclose to investors the receipts on funds lent out. Additionally, banks need a liquidity buffer since deposits are typically shorter term than loans, so they engage in maturity transformation which P2P lenders do not. Overall, P2P lending adopts a more customer-centric approach to how funds are managed, and their simplified model increases transparency.
Pros & Cons of P2P Lending P2P lending platforms have a lower cost operating model than traditional banks and are not regulated in the same way, enabling them to compete with advantages that the banks cannot. The pros of P2P include: • Better customer experience for borrowers, driven by speed and convenience. • Access to funds in an efficient and timely manner through faster decisions and competitive rates. • Less documentation needed for a loan application. • Absorbs and diversifies risk better by matching the appetite of borrowers and investors, and minimises risks by spreading lenders’ investments across a large number of borrowers. • Affords increased transparency by allowing investors to choose whom they lend to.
Critics argue that P2P lending gives a false sense of security about the balance of risks versus returns to the investor. In response, P2P platforms have introduced visible cautions on their websites about the risks of default. While this form of lending may sound innovative, it has drawbacks which borrowers and investors should be mindful of. • Some P2P platforms still require traditional documentation e.g. financial statements, forecasts and business plans for at least two years, thereby eliminating start-ups. • In some markets, P2P lending is not regulated so provides limited protection of funds invested, and lenders may impose higher interest rates than banks due to higher default rates. Some platforms may even impose borrowing limits. • Tangible projects (e.g. plant and equipment) have higher rates of funding.
The Way Forward Globally, P2P lending continues to develop, but within the Caribbean Community (CARICOM) growth is slower. Carilend, a Barbados-based P2P lending platform, began operations in May 2017 focusing on personal lending. CARICOM is yet to see a P2P lending platform incorporating lending to SMEs and other businesses.
However, it is anticipated that with the continued growth in SMEs’ contribution to economies across the Caribbean, one such P2P lending platform will emerge, but for the established SME seeking finance for growth, the commercial and development banks will continue to be a primary source for financing. ¤
Tannel George [email protected]
By: Michelle Stephens