|Alternative Funding Network|
P2P Supply and Demand: A potential short-term lending shortage?
In microeconomics, the principle of Supply and Demand determines the ebbs and flows of the market. When looking at the development of the alternative finance industry, the success of P2P lending for SMEs is anchored on engaging lenders. And so far, P2P lending is doing a pretty good job. In the last year, we’ve seen exponential growth and a continued increase in loan creation. Yet through our research, a few observed trends could potentially cause P2P lending some growing pains…and that is in the form of demand outstripping supply.
The contraction of bank lending to SMEs is well publicized. Industry and government players alike have used these reports to herald in a new era for SME finance through alternative venues. Yet despite all of this attention, especially over the first quarter of the year, new SME activity across the sector has grown at a pace akin to the previous period, albeit positive growth. Investor activity, on the other hand, has experienced growth that is exponential in comparison.
The amount of investors in alternative funding models is increasing at a seemingly unstoppable pace. When looking at investor activity into the P2P space, our research showed that in the span of one year, the number of individuals investing through a P2P platform more than doubled. More than that, just over 54% of investors surveyed engaged more than 10% of their net-investable portfolio though P2P Lending. In fact, 24% were investing more 20%!
Although these are encouraging numbers, our findings also indicated that the same rate of activity could not be said of the ‘demand’ side. Our most recent data collection (over Q1 2014) revealed that the rate of new SME activity across the sector, while growing positively, was being outstripped by investor demand. At present, this uneven growth is yet to present itself as a major problem. Perhaps it never will. Yet, there does exist the possibility that as demand for investment grows at a faster rate than supply of new SME loans, a choking out effect may be at play.
In Q1 of 2014, our data suggests that a large percentage (almost half) of new loan opportunities came from an existing SME base across lending platforms. That is to say, SMEs that had previously achieved success were likely to use their designated platform for a second or even third round of funding. Given the large number of repeat SMEs, this would seem to be a ringing endorsement. It is proof that SMEs who have used the system appreciate it and come back for more. However, given the largess of repeats, this also indicates a potential problem in how the model attracts or engages new SMEs.
The issue of lower new SME take-up may be due to lack of awareness or education on how lending models work for SMEs. Our phase two research covered over 100 SMEs who arguably were the cream of the crop; the majority of which had recently sought external finance. Our results indicated that high-growth businesses were receptive to alternative models and, on the whole, agreed that alternative facilities would engender greater financial accessibility. Yet, despite this, a grand total of ZERO decided to use a platform to access their needed finance. On the contrary, despite a general displeasure with traditional lending facilities, these businesses still opted for a bank loan or overdraft when possible. Based upon their comments, the displeasure of going the traditional route was palpable.
More to the point,a vast majority of these SMEs felt some level of trust towards alternative models, especially against the banks and traditional tools they were using. But when probed, it became clear that what these businesses knew about alternative models was little more than the most recent media headline. Of those SMEs who used a financial advisor, less than 10% could speak to them about alternative models or explain how they might be utilized. With such limited knowledge, it is not surprising that take up by new SMEs over Q1 was nearly equal to that of repeats.
The Possible ‘Crowding Out’ Perpetrators.
For successful offers, around 100 individuals are required to fill a loan. As such, having a large number of active investors is essential for success. Our most recent data indicated a continuous increase in new active investors across platforms. In Q1of this year, a near 25% increase of new investors across the market suggests that investor participation is very much on the rise. And, as mentioned earlier, existing investors are eagerly becoming more active in their lending activities. At first glance, this upward trajectory would support the growing industry. However, some of the findings from our research present a cautionary tale. Specifically, that investor interest might outstrip currently available loans.
The first note-worthy issue was that of narrow diversification. Of the 250+ investors surveyed in our phase 3 research, we noted some concentration risk amongst the most active of investors. These investors indicated that the types of loans they were participating in across a platform tended to fall within similar constraints (ie sectors or risk brackets). With a growing number of repeat SMEs on a single platform, this problem may be exacerbated further. Similarly, while a large number of investors did participate in loans from more than one platform, there was a strong indication of ‘primary platform use.’ That is to say, investors were limited to only a handful of platforms, with great overlap in the loan-type offered. Perhaps one way to combat this concentration issue is to encourage investors to lend across a variety of platforms, to ensure that ‘double-dipping’ is at a minimum and more opportunities are taken advantage of.
As new SME activity grows at a slower pace, another area of concern is that the increase of active investors and their willingness to increase their average investments may cause a ‘crowding-out’ effect. At present, the investor demand seems to be satiated by the current SME base. However, investing may become a race to the finish line. In our first phase of research, we had noted that success rates for P2P lending was about 60-70% across platforms. In our most recent research, we are noting an uptick to success rates. This is true of some of the larger platforms, and especially true of invoice discounting platforms. Obviously, loan success is linked to the quality of the loans on offer and the rates investors achieve. But success is also linked to a growing number of investors competing over the same pool.
A final ‘crowding out’ perpetrator may come from government and institutional investments. The idea of increased government and institutional involvement in the P2P lending arena has long been viewed as a major legitimizing factor for the successful development of the industry. As an observer, I fully agree. Nonetheless, an increase in public money into P2P loans may exacerbate the crowding out issue noted above. Lending programs such as those provided by The British Business Bank certainly help advance SME funding within the UK. Yet investors indicated that the utilization of such programs also prevented them from investing in many ‘good’ loans, or curtailed their level of investment. In the case of Funding Circle, for instance, government-based funding is used to fill the last 10% of a successful offer that has reached 90% from individual investors. Some may argue that this automatic loan-filling is actually preventing private individuals from partaking in a loan otherwise available to them.
The industry is still in development, so the issue of investor demand outstripping SME supply is perhaps of minimal concern to date. Yet, if current rates of investor activity increase and new investors continue to register at the observed speed, there is potential for short-term loan shortages. Worse still, with a crowding out from the best available loans, investors may feel pressure to participate in loans that would otherwise fall outside of their risk/reward brackets. Such overzealous activity might lead to unintended consequences, where SMEs that would otherwise fail on a platform become more attractive targets. With these thoughts in mind, the creeping unevenness in supply and demand may lead to disequilibrium and is an issue that deserves some redress. A leveling out of demand against supply can prevent short-term shortages down the line. As the P2P lending arena becomes an increasingly attractive place for investors, increased SME activity is the key to even development.