Credit underwriting concerns surface in the alternative finance sector

The alternative finance sector has grown rapidly since 2008 and like all fast emerging areas of the economy is liable to come under criticism by those concerned about slipping standards.  Lord Turner, former head of the Financial Services Authority, raised such concerns this morning in an interview with the Today programme on BBC Radio 4.

Lord Turner is right to raise concerns, but wrong to think the sector is not aware of them.  His comments centred on whether there is sufficient credit analysis being undertaken by P2P lending platforms, and whether the platform’s marketing sufficiently discloses the risks consumers are taking by investment in them.

Taking his last point first: the P2P lending sector is one of the first in financial services history to lobby for more regulation of its activities. All the established platforms have realised that in order to gain the trust of the public in the wake of the numerous bank scandals over the past 10 years that they need to be subject to the same tight modern standards as all financial services businesses. 

Regulation that came into force in April 2014 requires all P2P lending platforms that accept investment from members of the public to apply for permission to operate with the FCA. They are subject to the same requirements that apply to other investment platforms, such as the segregation and protection of client money, fair and not misleading marketing, full and proper risk disclosures, strict data security, and funds set aside to mange the administration of platforms in the event of failure.

How to address Lord Turner's point?

Recognising the same concerns as Lord Turner, we have designed Growth Street – which is a marketplace lending platform but which does not currently allow consumers to invest – to go two steps further in protecting lenders. 

The first is on the underwriting side, where we recognise that lenders are often neither skilled enough nor engaged enough with their investments to make proper underwriting judgements. Therefore, in addition to extensive financial analysis, we have a detailed conversation with every company that applies for credit in order to fully understand the business and “kick the tires”. Uniquely among lenders – bank or otherwise – Growth Street also integrates with borrowers' accounting platforms to ensure that we always have access to the latest financial information. This enables us to offer borrowers the most accurate and cost effective risk based pricing, but also allows us to proactively manage potential issues on behalf of lenders before they impact their investments, rather than passively waiting for issues to occur.

The second is a loan loss provision fund that pays lenders out in full, plus any accrued interest, should the borrower in their loans default. This provision fund is funded by credit spreads that are charged to borrowers, at a rate equivalent to their risk profile, and also by additional capital provided by Growth Street itself. This fund not only ensures that lenders are protected from defaults, but also aligns Growth Street with our lenders. Our capital is the first to go if our underwriting proves inadequate, and this provides a powerful incentive for us to be thorough both when first underwriting a borrower, and on an ongoing basis. Again, we are not aware of any other lenders – banks or otherwise – that engage in such detailed and ongoing underwriting of borrowers.

Lord Turner focused on the investors on P2P lending platforms, but didn’t mention borrowers. At Growth Street, we are actually much more concerned about the potential mis-selling of small business borrowers. While retail investments in P2P lending platforms have been regulated by the FCA since 2014, commercial finance remains an unregulated activity. This is a particular concern when it comes to pricing, as financial products are not required to carry an Annual Percentage Rate (APR). This leads to a fundamental lack of price transparency – and therefore lack of competition.

Growth Street has recently started an APR4SMEs campaign calling on the government to take steps to mandate an APR across all commercial finance targeted at SMEs.

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Chief Executive Officer