Peer-to-peer lending: what’s in a name?

Retrace the history of the industry arriving to settle on Peer to Peer lending.

It may seem surprising given the embryonic development of Australian peer-to-peer lending, but it was over 10 years ago that the first such lenders emerged in the UK and USA. As well as pioneering a new business model, these early innovators were also challenged with coining a name for what they were up to.

One early UK platform, playing on public understanding of other disruptive exchanges such as Betfair, was fond of referring to itself as a ‘lending exchange’.

Another early candidate was ‘social lending’, which had prescience amid the rise of social networks. The communal trust relationships implied by ‘social’ may have also helped subvert sceptics concerned about the merits of lending to strangers over the internet.

The association with social networks was always strained, however, and it wasn’t long before an alternative name gained favour. ‘Peer-to-peer’ lending was born. Not only was this pleasingly alliterative, it succinctly and simply described the concept: people borrowing and lending with each other on an online platform, without a bank in the middle.

A rose by any other name

With the tremendous growth and publicity of peer-to-peer lending globally there is now powerful cachet in the term. But public understanding has lagged the growing diversity of non-bank online lenders.

My favourite anecdote in this vein concerns a Chinese property developer and building materials supplier who, upon changing their name to Pi Tu Pi Financial Information Services, was the beneficiary of a 10% share price spike.

Much less cynical – though similarly mischaracterised on occasion – are lenders more properly termed ‘direct lenders’ or ‘online lenders’. Similar to most peer-to-peer lenders, borrowers seeking a loan from a direct or online lender will discover a pleasing contrast to the frustrating paperwork associated with a bank loan.

The emergence of many of these companies should be welcomed. The budding Australian direct lending sector has flourished in small business lending, a segment that has languished for too long under the stewardship of the Big 4. But however valuable these direct and online lenders are, they are not peer-to-peer.

Know the difference

Peer-to-peer lenders facilitate a transparent, two-sided online marketplace that allows ordinary Australians to choose the rates or loans they wish to fund. Some, such as RateSetter, incorporate a provision fund to help protect investors from any borrower late payment or default.

In contrast, direct or online lenders use institutional and wholesale money, much of it the same offshore money that funds the balance sheet of traditional institutions, to fund loans. In many cases, the loan will be held on the lender’s own balance sheet.

Other direct or online lenders allow investors to participate via pooled funds, where a lender’s return depends on the performance of a portfolio of loans – similar to the way some traditional finance companies might have been structured. These structures introduce risks that do not exist with peer-to-peer lending, such as unfair treatment of investors when they withdraw their funds, given an inability to know the net return of the portfolio until all loans are repaid.

Open for business

The term peer-to-peer carries clear implications (and often, requirements) of equality, and we are resolute that any platform described as peer-to-peer should uphold this principle. We think peer-to-peer lenders should allow access to all who wish to invest and should ensure the equal treatment of participants.

We think it’s problematic that some lenders who make no allowance for the participation of everyday Australians are nonetheless referred to as peer-to-peer. A funky website does not a peer-to-peer lender make.

Rates by the people, for the people

At RateSetter we think the fundamental promise of peer-to-peer is empowerment. For too long people been subject to the whims of an entrenched, structural financial elite, and we’re all about giving back power and ownership.

We see particular value in the peoples’ rate – the price of money determined by ordinary people borrowing and lending in a free market for personal loans at rates of their choosing.

A so-called peer-to-peer lender that funds loans on their own balance sheet, treats lenders differently, or pools lender money, cuts against the grain of what we think peer-to-peer lending is all about. So when evaluating whoever may now be describing themselves as peer-to-peer, ask a few questions.

Can I invest? And who is my peer?

This information does not constitute financial advice and you should consider whether it is appropriate to your circumstances before you act in reliance on it. Any opinions, forecasts or recommendations reflect the judgement and assumptions of RateSetter as at the date of publication and may later change without notice.