Fintech: RateSetter – dwarf in a land of giants

By:
Peter Lee
Published on:

Keeping it simple is already paying dividends for the UK’s biggest P2P lender.

In 2014 RateSetter lent £293 million, making it the biggest peer-to-peer lender in the UK, just ahead of Funding Circle, which lent £280 million, and Zopa, which lent £265 million.

These three, together responsible for just over £800 million in annual lending, probably account for 70% of the UK's peer-to-peer lending market. "We’ve got to be realistic. That’s just a pin-prick compared to annual bank volumes," says Rhydian Lewis, co-founder and chief executive. The platform is a marketplace for establishing lending rates by matching lenders and borrowers, aiming to give lenders much higher rates than they can get on bank savings accounts and borrowers much lower APRs than they pay on bank loans.

"But I’m quite comfortable with where we are, and I expect growth to accelerate from here. We could lend £600 million this year and £1 billion next. It could well be that 2015 is the year the dam breaks and more intermediated and self-directed money flows in when peer-to-peer loans become eligible for ISAs [the UK government’s tax wrapper to encourage savings].

Rhydian_Lewis600x400
Rhydian Lewis, RateSetter

"I’m reminded of what Bill Gates once said about building tech companies: that the market typically overestimates what should be achieved in the first three years and underestimates what can be achieved in 10. For now, what’s most striking about peer-to-peer lending is not that it’s small scale but that it exists at all, because establishing anything new in finance, which is all about trust and track record, is difficult."

RateSetter does what all new fintech start-ups aim to do. It offers a better price and a better service to customers than the banks by running state-of-the-art technology, while the banks struggle with horrible legacy systems and bricks-and-mortar costs. In late February, it was offering lenders rates from 3.3% for one-month money up to 3.7% for one year, 5.1% for three years and 5.9% for five years. That’s well ahead of any bank bond or savings account. It was quoting an average APR for borrowers of 7.7%.

What’s most striking about peer-to-peer lending is not that it’s small scale but that it exists at all, because establishing anything new in finance, which is all about trust and track record, is difficult

Rhydian Lewis

The drawback for peer-peer lenders has long been that savers in the UK enjoy a guarantee on up to £85,000 of deposits at any UK bank if it goes bust, giving a sense of safety much needed in the aftermath of the near collapse of the UK banking system six years ago. But even risk-averse Britons with cash to put to work are asking if that guarantee of safety justifies accepting rates as low as 0.1% on some zombie UK bank savings accounts.

"Deposit insurance doesn’t come free. Customers pay for it with low returns," says Lewis. "And the cost for banks of providing unsecured personal lending is going up dramatically for other reasons too. It used to be they could put up around £375 of capital against a £10,000 unsecured personal loan. Now they have to put up nearer  £1,000. We may well be building a banking system that is risk-free, but one that offers no value whatsoever. Meanwhile deposit insurance has been a blanket that the banking industry has used to cover many shortcomings, including poor customer service and terrible rates for lenders and borrowers. I’m not sure what brand or cachet the high street banks have left with customers anymore as they now become more utility like."

Pool insurance

RateSetter was established in 2010 and opened its doors in 2011. Early on it decided to address the absence of deposit insurance with a provident fund, a pool of insurance to compensate lenders that borrowers pay for as part of their loan margin. In mid February, the provision fund amounted to £11.8 million, against £312 million of outstanding loans, enough to cover 148% of claims. To date, no lender through RateSetter has lost a penny. However, the firm has been operational through a period of exceptionally benign credit conditions when default rates have been at historical lows.

"The real reason for our low loss-rates is that we’re very good at credit," says Lewis. "We only approve one borrower in five that approaches us. Our head of retail credit spent 10 years at Lloyds Bank." The company uses traditional credit checks, such as Callcredit and Equifax, as well as some newer data sources, including those devised by the phone companies to minimize fraud. It grades borrowers into 13 categories and segments pricing and contributions to the provident fund accordingly.

Lewis sees a fundamental shift now underway in the lending business driven by the regulatory response to the financial crisis. "Regulators are happy to see lending grow on our kinds of platforms because it makes sense for loans to be funded by risk capital, not against deposits. If default rates rose dramatically and our lenders got back 98p in the pound, that would be highly unfortunate but it would not be the end of the world, whereas if a bank fails to give a depositor back anything less than 100% it is the end of the world. The lack of guarantee in our system is perversely one of its strengths – we don’t pretend to something we are not, whereas banks purport to be safe but every 50 years are exposed as unsafe."

He sees regulators being required to promote competition and innovation as a big support to the UK fintech scene. "It’s very vibrant. I think the arrival of many US venture capitalists with lots of money to invest from previous wins in the tech sector has completely changed the dynamic in the UK, where previously UK investors have been more conservative around technology."