That’s the question raised by the news today that Government is looking at a tax free ISA for peer to peer lending.
The connection between financial exclusion and the new savings product is best examined by starting with who lends to people on low incomes at the moment. One major set of players is the pay day lenders. The high cost of the credit they provide has been in the news a lot but it’s not been obvious how to reduce the cost without reducing access to credit as well.
In some areas at least the competitors to payday lenders are credit unions. An assessment of the previous government’s credit union growth fund suggested that the cost to credit unions of providing credit to people who are financially excluded, once you write-off the loans that don’t get paid back, was 40% annually on the portfolio. It’s no accident that the present government has raised the maximum interest rate credit unions can charge to 3% per month (42% APR). This will help them to compete but there’s a bigger opportunity for competition too.
Peer to peer platforms are enjoying a big rise in interest from savers who want to get a better return on their money. Currently though peer to peer platforms can’t compete with payday lenders. This is because the cost of providing credit is in large part the write-offs associated with people who don’t pay back and, under present tax arrangements, individuals who lend on a peer to peer platform are taxed on the interest they receive without being able to offset the loan losses. For businesses that lend those write-off losses are tax deductible. So, at the moment, the peer to peer platforms only lend to very high quality borrowers to minimise the non-tax deductible losses and can’t compete on lending in the target market for the payday lenders.
However, what would happen if people using peer to peer platforms could offset losses against the income? Then lending to the financially excluded would be possible for a peer to peer platform. And economic theory would state that we get closer to a clearing price for credit, rather than, a price set by payday lenders alone. One way to get to that place is to change the tax rules so that the loan losses are offset. The other way to do it is to not tax the income gains, and that’s what happens if there is an ISA for peer to peer lending, as the Government is now considering. What that does is level the playing field between the platforms and the lenders.
Lending directly to people is in a way still the 16th century model of allocating credit. The peer to peer platforms, enabled now by technology, change that model. We’ve been searching around for a way to boost competition in financial services. Creating an ISA for peer to peer lending could be bigger than anyone realises, allowing the peer to peer platforms to expand beyond a niche, creating new options for borrowers as well as giving savers a simple, salient route to higher returns than many high street banks are currently able to offer.