WIREDGOV

The popularity of peer-to-peer lending to small businesses has grown in recent years.

Ever since the 2008 banking crisis, many banks have been unwilling to lend to companies perceived as higher risk, particularly small- and medium-sized enterprises (SMEs). Some of this funding shortfall has been addressed by the emergence of crowdfunding or peer-to-peer lending – the provision of loans for new projects via the internet with a large number of disparate individuals each making relatively small contributions.

Providers like Funding Circle in Britain and Kickstarter in the US have internet platforms that use big data to evaluate the riskiness of potential borrowers and allocate investor funds to loans. Founded just five years ago, Funding Circle now has over 42,000 investors and has lent more than £800 million to around 10,000 businesses. Borrowing sums for up to five years, successful companies typically receive the funds within a week of application.

Reasons for growth

Professor Jerry Coakley of the ESRC Business and Local Government Data Research Centre suggests several reasons for the growth of peer-to-peer lending to SMEs:

• There is a shortage of funds from conventional sources like banks.
• It’s convenient: companies apply online instead of having to visit their local bank.
• The loan rates are cheaper than for equivalent bank loans: sitting outside the formal banking system, crowdfunders are not subject to bank capital requirements that are equivalent to a tax on bank loans, and providers have relatively low overheads.
• The funding rates of 7.5 per cent are attractive in an era of low interest rates.

Peer-to-peer loans carry varying degrees of risk and, unlike bank deposits, they are unprotected, but these risks may result in an impressive rate of return to investors. And from 2016, those involved in crowdfunding to established SMEs through platforms like Funding Circle will be able to offset for tax purposes losses from bad loans against other crowdfunding income.

Further information

• ESRC Business and Local Government Data Research Centre

This article was originally published in our Britain in 2016 magazine.