UK peer-to-peer lending is about to face its toughest test since the sector was born

Action off the start line in the Fast 40+ class during Aberdeen Asset Management Cowes Week on August 6, 2016 in Cowes, England. (Photo by )

LONDON — There are growing signs that the UK's peer-to-peer lending sector could be experiencing the toughest test of its lending abilities since the nascent sector's inception.

GLI Finance, a listed investment company that backs fintech businesses, on Monday wrote down the value of its investments in eight peer-to-peer lending platforms by £12.6 million to £28.9 million, citing "concerns over the collectability of some platform loans."

The disclosure came after concerns were raised above fast-growing peer-to-peer lender Lendy Finance over the weekend. The Sunday Telegraph reports that a quarter of its loan book is now considered to be in default.

Meanwhile, Zopa, the UK's oldest peer-to-peer lender, last month wrote to investors telling them to expect higher-than-forecast losses as a result of deteriorating credit conditions. And peer-to-peer platform Wellesley & Co. last year raised £2.5 million to "absorb impairment losses that would otherwise have been passed on to peer-to-peer investors."

The backdrop to all these disclosures is a surge in unsecured consumer borrowing and rising inflation in 2017, factors which are combining to fuel fears people may be unable to pay back all they have borrowed. Unsecured consumer borrowing hit £202 billion in July, the highest level since 2008. Meanwhile, inflation is running at 2.9%, well above wage growth.

Not all online lenders lend to consumers — some extend loans to businesses. However, consumer spending fuels around 60% of GDP growth in the UK and any consumer downturn could have knock-on effects for businesses. GDP growth is already anaemic at 0.3%.

This could be a huge test for the peer-to-peer lending sector, which comprises online platforms that match investors looking for attractive returns with either consumers or businesses looking to borrow. The sector was invented by Zopa in 2005 but only really took off around 2010. Today it is worth an estimated £12 billion, according to AltFi.

Critics say the underwriting facilities of peer-to-peer lenders have yet to be properly tested by a downturn. Chirag Shah, founder and CEO of Nucleus Commercial Finance and a former banker with Merrill Lynch and Wachovia, told Business Insider last December: "We have interviewed risk guys from a variety of these platforms. When you interview them you learn a lot about their underwriting processes. In most cases, we are learning that they are just not up to the standard."

Shah added: "The easiest thing in the world right now is getting the money out. The difficult thing is getting it back."

Zopa is the only platform to have experienced a downturn and likes to point out that its business fared well during the 2008 crisis. However, credit ratings industry Fitch said in a note last year that a change in lending criteria over recent years means it "cannot accurately predict how these loans will perform in a stressed environment."

Any rise in defaults across the sector is likely to mean lower than expected returns for many of the thousands of retail investors who have piled into the peer-to-peer lending sector.

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