ThinCats Founder and Chairman Kevin Caley was at the forefront of the peer-to-peer market offering loans to businesses five years ago. His platform has provided over £200m of loans in the UK and helped shape the UK’s alternative finance revolution.
In the latest interview in our Investor voices series, Caley talks to BusinessZone editor Chris Goodfellow about the industry’s biggest challenges after a year where growth slowed, regulation increased and there were a series of bad news stories - and ahead of a potential windfall of government-incentivised investment.
Peer-to-peer lending was a product of the financial crisis. The problems of low -interest rates for lenders and the banks not behaving as they should opened up an opportunity. The banks had a total monopoly on loans and they could undercut everyone. In 2008, the banks dropped the ball and stopped lending, and suddenly we had an opportunity to move into that gap for the first time in probably 300 years.
It was a remarkable change in the way things were done. The key thing now is; can we get a sufficient foothold, so that if the economy improves and the banks come back into the market in a big way we’ll be able to withstand that? I think it will be five years before the banks even consider that. Things may have changed forever.
We launched within a few weeks of Funding Circle and have just passed our sixth birthday. We had our idea at about the same point they did, which was to copy what Zopa was doing for personal lending and use it for businesses. We had to prove it worked, but we had a two-year headstart on everyone else. We made £2m loans in our first year, most of which came from founders and shareholders. I think we did about £5m in the second year, then it doubled each year after that.
We came at it from being relatively old cynical equity investors looking for low-risk investments - we were looking for secured loans. The sort of money you would put your pension into. Funding Circle approached the opportunity as relatively young graduates. They thought ‘crowdfunding’s a good idea, let’s use it to solve this issue businesses have with raising funds’. They set about using automated credit checks and things like that to get the volumes and they raised some capital and spent a lot of money on marketing. We basically hung on their shirt tails - let them do the marketing.
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The sector is dominated by larger players. It’s like any other exciting new market; you have the pioneers that set it off, some of whom don’t do well and fall by the wayside, others who start to grow. And then people think: ‘Oh, that’s a good idea, we ought to be doing it.’ They’re three or four years behind, they have such a lot of catching up to do and they’re going to have to have such a special offering to compete.
For new platforms, it’s like having a runway; you only have so many years to get up to speed in order to fly and without the volume to get off the ground you’re going to crash. In the meantime, some of the big platforms have taken off and left you in the dust. There are some niches there, some opportunities, but you’ve got to be offering something pretty special.
Regulation is a big burden. When we started talking to the Financial Conduct Authority they said they considered P2P to be low risk. They said: ‘It’s a very innovative sector, we like that you asked to be regulated and our new remit is to promote competition.’ I liken it to being invited into a swimming pool by a group of sharks. The regulators say: ‘Well we’re very friendly and the waters warm and we’ll only nibble you a little bit.’ But having spent all these years running VC funds and knowing what can go wrong with regulation I’ve always been a bit nervous.
In the last year, we’ve changed our lending criteria and we only considering listing people when our institutional investors are willing to put in funds. That cut out about 20-25% of the loans we would have put on the platform in the past, but the quality’s going up. The average size has also been increasing.
The volume of loans that P2P platforms are doing is growing rapidly, but it’s tiny compared to the business end of the market. We’re not even at 2%. It will be three or four years before we get to the point where we’re doing maybe £10bn and that’s 10% of the market.
If you’re a P2P platform that’s relying on institutional money you have a few investors that are calling the shots. They might say they want to get a minimum of 7% and decide what they will invest in. That’s a big problem for the ‘retail’ P2P lenders. It’s about allowing individual lenders to make the choice of who they want to lend to; there is a danger that institutional investor are going to swamp the market if we’re not careful.
The Individual Savings Account market is something like £80bn per annum of new money. The Innovative Finance ISA will probably pay between 5% and 7% per annum - when it’s finally launched its going to be extremely attractive. Over the next year, it could attract 5% of the market, that’s £4bn. We’re talking about a doubling of the market in the next 12 months. That’s a huge amount of money coming toward the industry. I don’t know whether we have the capability of handling it.
They’ll be a great temptation for large platforms that want to continue on this treadmill of growth. They're going to want to get as much of the ISA market as they can and they’re going to want to find a home for it. Where are you going to find the deals? The platforms can either increase the amount they lend to each company or possibly lower their standards. That is a risk.
Read our deep-dive article on the future success of the peer-to-peer lending market and the impact of the Innovative Finance ISA here.