Across the pond, US banks are slowly but steadily increasing interest rates again.
Federal Reserve rate hikes and fierce competition from online banks willing to pay 2% interest force banks to offer better rates.
In the UK, interest paid over savings is still at a dismal level. A lot of Brits have therefore shifted their funds to alternative investments that still pay.
Peer-to-peer lending (P2P) is one of the up and coming ways of investing. And it’s not difficult to see why it’s getting more popular.
It’s considered less risky than investing in stocks while the returns are a lot higher than money deposited in an ordinary savings account.
It seems like a win-win: businesses and individuals get access to capital and investors earn a decent rate of return.
But now the Financial Conduct Authority (FCA) is threatening to rain on that parade.
It believes P2P is much riskier than it’s made out to be and wants to make it a members-only club for the very wealthy.
If the FCA gets its way, it’ll close off this avenue of investment to a great deal of P2P investors in the UK.
How peer-to-peer lending works
Peer-to-peer lending isn’t the same as storing your money in a bank, but the “behind the scenes” process is quite similar.
When you give your money to a bank for safekeeping, the bank lends it out to other people or businesses. The same goes for building societies, though they mostly turn your deposits into mortgage money.
Banks and building societies play the middleman. You don’t know where your money ends up and you don’t really care, as long as you can access your money whenever you want and (in days gone) you receive interest over your deposits.
P2P platforms also put your money to good use (depending on where it ends up, of course). It’s a place where savers and borrowers are directly matched up.
You know who you’re lending your money to. You can also ask P2P platforms to slice and dice your investment across many borrowers to reduce risk.
Because you bypass banks (which always take a big cut), it’s possible to achieve interest payments north of 5-6%.
The downside is that P2P investments are not covered by the Financial Services Compensation Scheme (FSCS). So if the borrower can’t pay, the lender has a problem. And you usually tie up your money for a longer period, though there are easily accessible accounts as well.
There are risks of default, but P2P loans are often secured against property or other assets and losses so far have been low.
P2P investing isn’t as safe as a savings account, but it’s not considered highly risky either.
Until now, that is…
The FCA wants to classify P2P as “high-risk” and bar most retail investors from access to these platforms.
But it might want to tell the other side of the story as well, which is that savings accounts are no good either…
“I’m all for pointing out the risks involved with investments and peer-to-peer is no different,” says Income For Life editor Greg Robinson.
“But where are all the official warnings that investing in a traditional savings account is guaranteed to slowly destroy your wealth?
“Where are the official warnings that traditional high street banks have repeatedly ripped off their own customers and are quite likely to do it again given half a chance?”
Maybe in a few weeks’ time, the FCA will suggest we hide our money under our mattress again…
A confusing move
Just as the peer-to-peer lending market is starting to come of age, the FCA wants to stifle it.
The UK regulator is determined to block access to the sector for the vast majority of Brits.
Only “sophisticated” and “very wealthy” people who are advised by an authorised person and promise not to put in more than 10% of their assets will be allowed to invest in P2P loans, reports the Financial Times.
In practice this would mean that P2P platforms would have to tell many of their current clients: I’m sorry, but your money ain’t long enough.
It’s a confusing move by the FCA.
While there are certainly risks to P2P lending, it’s still quite a low-risk alternative to savings accounts (and savings accounts pay zip!).
It’s one thing to shield people against risky investments; it’s another to babysit an entire population.
The other puzzling thing about this move is that the people leading this country are now sending mixed messages.
With the introduction of Innovative Finance ISAs (IFISAs), the government has indirectly endorsed this route to higher returns.
Regular cash ISAs allow savers to keep their interest sheltered from the taxman. IFISAs work the same way except for income made from alternative investments like P2P.
Now another branch of the government – the FCA – is considering cracking down on this new investment sector by limiting access only to “wealthy sophisticated investors”.
Why would the government create IFISAs if it considers these investments too risky for just about every person in the UK?
“Peer-to-peer is a great way to democratise lending. It should be regulated, but allowed to flourish,” says Greg.
“Surely we can treat all investors as grown-ups and let them make their own decisions about what they do with their own hard-earned money?”