Consumer lending: Under-consumed

The consumer lending market is in high demand, but challenges remain for the few peer-to-peer lenders who remain in the space. Kathryn Gaw reports…

If you have been paying attention to the personal finance pages, you will know that there is a new consumer credit crisis brewing.

The rising cost of living, paired with the higher base rate and low wage growth means that many households are struggling to make ends meet.

Earlier this year, data from the Office for National Statistics (ONS) revealed that more than a fifth of adults in Great Britain increased their borrowing, year-on-year. This equates to approximately 11.5 million consumers. Almost a third of those surveyed by the ONS said that they would be unable to afford an unexpected expense without access to consumer credit options.

Read more: Consumer borrowing up 17pc due to cost-of-living crisis

According to the most recent Bank of England statistics, the average net borrowing statistics have remained stubbornly high since the start of 2022, split roughly 50/50 between personal loans and credit card debt. However, base rate rises mean that the cost of consumer borrowing is going up.

In May, average rates on credit cards reached 22.76 per cent – their highest level since December 1997. At the same time, overdraft charges hovered around 21.7 per cent.

For consumer borrowers, the best rates are still being offered by banks, but these prices too are going up. In May, the effective rate on new personal loans to individuals was 8.27 per cent, although the actual rate depends on the borrower’s credit score, and the terms of the loan. Just two years ago, it was possible to get a personal loan with an interest rate as low as 2.16 per cent.

The dramatic increase in the cost of credit has long-term repercussions for the consumer lending market, particularly among those who are relying on borrowing to stay on top of their day-to-day expenses.

Read more: Plend teams up with non-profits to deliver loans to vulnerable borrowers

“Demand is increasing as more people are being locked out of mainstream credit, but this pre-dates the cost-of-living crisis,” says George Huntley, chief executive of The Money Platform.

“The number of people with access to a credit card or overdraft has been declining for several years now. In research carried out before the Ukraine War, the Centre for Social Justice estimated that 1.08 million used illegal lenders – so demand for those excluded from mainstream finance has been at elevated levels for some time.”

This demand is being met by a range of alternative consumer lenders, including a clutch of consumer-focused peer-to-peer lending platforms. They include short-term consumer lender Fund Ourselves, alternative credit card provider Elfin Market, education finance platform Lendwise, P2P pawnbroker Unbolted, short term lender The Money Platform, and new kid on the block Plend, which has not yet opened to retail investors.

These lenders have a shared mission – to bring affordable and accessible financing solutions to people who truly need them, funded by retail investors.

“There are many parts of the consumer lending market that are underserved and these are segments where P2P can play a part,” says Mike Carter, head of platform lending at Innovate Finance.

“Examples being Lendwise in education loans, Plend in the near-prime market and The Money Platform’s new products in the mid-prime market. There continues to be opportunity for product innovation which P2P platforms can lead.”

However, while opportunities remain, there is no denying that the P2P consumer lending market has changed considerably over the past few years. Some of the biggest P2P consumer lenders opted to leave the market completely as they sought to scale up. P2P pioneer Zopa is now a bank, offering personal loans at 22.9 per cent APR. By contrast, when it was a P2P lender, Zopa’s consumer loans were consistently priced in the single digits.

Read more: Plend calls for interest rate transparency

Lending Works and RateSetter exited the retail market some time ago, with RateSetter’s consumer lending business being acquired by Metro Bank. What was once a multi-billion pound segment of the P2P market, has visibly shrunk.

“Experience has shown that it’s not easy to make standard consumer lending work in P2P, so the conditions for it are always tough,” says Neil Faulkner, chief executive of P2P research and ratings firm 4th Way.

“Platforms focusing on general consumer lending need to find ways to make the interest rates attractive enough for investors through most market conditions, while educating investors to be patient and forgiving during severe downturns, when their returns are lower.”

It would be easy to assume that P2P lenders could swoop in to undercut the banks and gain access to a new generation of consumer borrowers. However, strict regulation and Financial Conduct Authority (FCA) oversight means that rather than ramping up their consumer lending, many P2P platforms are managing their exposure to this segment by choosing only the most creditworthy borrowers, and using technology to weed out any potential risks.

“The FCA has asked lenders to review their affordability and lending criteria due to the cost-of-living crisis,” says The Money Platform’s Huntley.

“Like other responsible lenders, we had already undertaken work to ensure that customers were not borrowing for ongoing financial needs leading them getting into a debt cycle, but rather for one-off needs. For our approved customers we are not seeing higher levels of defaults or forbearance required.”

Read more: The Money Platform achieves profitability for the first time

Like other P2P consumer lenders, The Money Platform uses in-house scoring technology to pull together masses of data points which create a clearer picture of what borrowers can actually afford to borrow.

“This allows us to be really precise when calculating affordability and determining creditworthiness,” Huntley says.

“We look beyond the raw credit score used by so many lenders as we know this discriminates against younger customers and migrants who don’t have a history of using credit. So often credit bureau data is months out of date and doesn’t reflect the customer’s current position. Our systems aim to solve that issue.”

This is a common theme in the modern day P2P consumer lending space. When Plend launched last year, its alternative credit-checking technology was pitched as its main selling point, and helped it to attract millions of pounds in institutional backing.

While banks tend to look at the same set of data points when deciding on a borrower’s creditworthiness, Plend, The Money Platform and other P2P lenders have the technology and flexibility to take a more holistic view. For instance, one of Plend’s key metrics for creditworthiness is evidence of rental payments being made on time, while evidence of unhealthy gambling habits would be flagged as a concern.

“Technology and data are the cornerstones of our strategy, with ongoing improvements to our credit decisioning, incorporating more tools, providing more data which in turn drives better lending decisions and so more financial inclusion and a broader product range,” adds Huntley.

“To this end, we have expanded our tech team considerably since last year, enabling some of the changes outlined and setting us up for the year to come.”

Read more: Serving the underserved: Interview with The Money Platform’s George Huntley

As demand for consumer lending continues to rise, access to this sort of bespoke credit checking technology will make P2P lenders stand out in a crowded field of consumer loan providers. But their challenge will be meeting demand without compromising on their lending principles, or alienating their retail investors.

“As consumer lending platforms grow, they find it increasingly difficult to maintain attractive interest rates for investors,” explains Faulkner.

“As more investors pile in, they need more borrowers to keep up with demand. The only way to get more of the very best borrowers now is to lower interest rates to compete with the wider lending market.

“As these platforms grow further, they need to add on more borrowers of lower quality to meet investor demand. While they charge these new borrowers higher rates to offset the risks, the overall downward competitive pressures on borrower interest rates mean that, after bad debts, it’s harder to offer investors the sorts of returns they want while competing with the banks for borrowers.

“And don’t forget they also have the substantial problem at launch of creating largely automated credit policies that rely on probabilities of default, yet they might well be without access to vast amounts of pre-existing data on borrower behaviour, making modelling difficult.”

By focusing on specific niches and constantly reviewing their credit checking technology, the UK’s remaining P2P consumer lenders have the opportunity to carve out a significant market share while also helping to ease the nation’s growing dependence on expensive credit card and overdraft debt.

“I think the P2P space is going to go through something of a renaissance in the next few years,” Huntley predicts.

As long as investors are aware of the risks, and borrowers are thoroughly vetted for suitability, this renaissance could take place sooner rather than later. The demand is there, it’s just a question of supply.