How will the UK’s peer-to-peer lenders react if interest rates are cut?
The Bank of England yesterday announced that the base rate would be held at 0.5%, despite widespread claims to the contrary. The markets had priced in an 80% chance of the Bank cutting rates, but the Monetary Policy Committee ended up voting 8-1 against the move.
The effect of movements in the base rate on alternative lenders has been the subject of much discussion over the lifetime of the industry. This time last year, the platforms were staring down the barrel of a potential hike in rates. Detractors of the peer-to-peer lending sector have suggested that a rise in rates would diminish the value proposition of peer-to-peer platforms for investors. Giles Andrews, Executive Chairman of Zopa, responded at the time by arguing that a rise in the base rate would only serve to widen bank spreads, which would be paid for by consumers – making the peer-to-peer lending proposition “even more compelling”.
The Bank of England said yesterday that “most members of the committee expect monetary policy to be loosened in August”. One option could be to cut rates, possibly to 0.25%, which would be a record low.
If rates were indeed cut, then there may be some adjustment to the rates charged by peer-to-peer lending platforms. A number of the big US marketplace lenders have raised rates over the past few months. Prosper raised rates for the second time this year in late May, by an average of 0.29% across its loanbook. The platform’s chief risk officer Brad Pennington said that the rate hike came “in anticipation of action by the Fed to raise rates”.
But Pete Behrens, co-founder and chief commercial officer at RateSetter, says that the cost of funding for his platform is not linked to the Bank of England, and that it finds its own equilibrium. “The RateSetter Rate is set by the tens of thousands of investors and borrowers in the RateSetter market,” he said. “If more investors start to lend, the supply of money increases, and – all other things being equal – the rate that borrowers pay should drop as a result. That means that the platform becomes more attractive for borrowers, whose demand pushes the rates back up."
Kevin Caley, founder and chairman of peer-to-peer lender ThinCats, said that a rate cut would be “miserable news for Britain’s hard-pressed savers, who have been earning dismal returns on their money since the financial crisis”. He says that interest rates are highly unlikely to return to pre-crisis levels any time soon, and that people with money in the bank “should be rethinking their savings plans."
Zopa’s head of risk Sharvan Selvam posted a column this morning on the potential impact of a shift in interest rates. Selvam first highlights the stable returns that were delivered by Zopa during the last recession, using the graph below.
Selvam also points to the predictability of the platform’s returns over the past decade. As can be seen from the graphic below, 2008 is the only year on record in which Zopa’s actual returns dropped below its expected returns.
Selvam says that Zopa uses performance data from this period to shape its credit risk and underwriting policies, which “are designed to deliver positive lender returns, even in economic conditions akin to the last crash”.