Think tank: Peer-to-peer lender's bank talks spark controversy

Last year, Funding Circle, the poster child of so called “peer-to-peer” lending, ran an advertising campaign with the tag-line “no thanks, banks”. Now, the online platform which “cuts out the banks” by directly linking savers frustrated by poor returns with credit hungry small businesses, is weighing up whether it should be saying “yes please” instead.

The company has held talks with Santander over a tie-up that could see the mainstream lender providing capital to boost the amount lent to entrepreneurs through its online partner. It might also see the bank passing on leads on small companies it isn’t ready to lend to, but which Funding Circle investors might be.

There are no signs that an agreement is imminent, but the fact that a deal is even being considered is remarkable. Such an arrangement would mark a controversial turning point for the fledgling sector, which has been providing a much needed alternative source of capital for small businesses.

Small companies like peer-to-peer not simply for providing them with cash, sometimes when banks won’t, but for providing it relatively quickly and painlessly. And many individual lenders take pride in seeing exactly where their money is going – often on tangible projects which create jobs.

The Government is clearly impressed, even lending money to small firms through Funding Circle and similar platforms. According to the Open Data Institute, UK peer-to-peer lenders have provided £550m of credit to businesses and consumers. A solid start for an industry that’s barely five years old.

However, compared to the £100bn that banks lend to small businesses, still a drop in the ocean.

There is something incongruous about a bank getting involved in peer-to-peer. People invest their savings in the bank because it is supposed to be a regulated, safe place and because the lender – in theory at least – makes sensible credit decisions. Granted, the financial crisis has shown that many banks failed on both of these counts.

But a peer-to-peer platform can’t pretend to be the former, and to some extent, abdicates responsibility on the latter. They are philosophically incompatible models. Indeed, banks’ default position on peer-to-peer lenders had been one of scepticism, even sniffiness.

Now at least one of them feels confident enough about the nascent industry to be considering getting into bed with one of its leading players. Barclays is also said to be interested in the sector.

Mainstream lenders getting involved with peer-to-peer would face questions over why they are willing to outsource their bread and butter – lending decisions.

Small peer-to-peer investors meanwhile would fear a bank’s ability to drive lending rates down – and that they would be asked to subsidise SME loans deemed high risk by banks.

For Funding Circle, which has had plenty of mileage from its independence from the bad old world of finance, letting the squares from the City in on their finance revolution would be a bold move. Unsurprisingly, there is thought to be some nervousness within the business about pressing ahead with the plan.

Even speculation about the talks led to criticism from other lending platforms last week.

Assetz Capital, which provides secured peer-to-peer loans to small companies, said such a relationship would endanger “the whole market” because the industry’s calling card is that it attracts “disillusioned investors and borrowers by creating a new future for finance”.

Their question is, how can you do that if you’re cosying up to the establishment?

But the peer-to-peer sector is likely to face some awkward growing pains soon and its leading players need to show their maturity. Funding Circle’s talks with a banking giant might not mean the industry has come of age, but it does suggest it has at least outgrown its short trousers.

Peer-to-peer’s leading players – which include consumer-to-consumer sites Ratesetter and Zopa as well as Funding Circle – will want to be seen as serious, established platforms rather than simply trendy upstarts if they’re to prosper during what some observers warn is a looming backlash.

The fair wind that has powered the industry’s progress – low interest rates and disillusionment with banks – won’t last forever. And the hugely tempting returns for small investors (sometimes more than 10pc) will be undermined if default rates rise.

With many of the industry’s standard three-year loans to small companies yet to mature (because the vast majority of them have been made recently), that seems inevitable. Industry insiders even claim that rates of defaults and losses being quoted on some sites now are not accurate and mask a growing problem.

If the peer-to-peer sector is facing a bad debt hurdle, the fear is that the whole industry could be tarnished by a platform or two failing to clear it, with consumers losing a chunk of their savings as a result.

That would be a shame. Peer-to-peer has plenty going for it. It has offered some good companies credit where banks wouldn’t. Arguably more importantly, while it isn't cheap money, entrepreneurs who use it praise the pricing transparency and speed of decisions it provides. Perhaps that’s why banks are so keen to get involved.

A tie up between a peer-to-peer platform and a high street lender would at least show how serious the sector is about wanting to provide a sustainable alternative for businesses and consumers looking for credit. But it mustn’t be done at the expense of what has made it a success to date – a straightforward deal for businesses and consumers.