How does peer-to-peer lending work?

#What is peer-to-peer lending?

In a normal bank loan, you deposit money with a bank and the bank decides whom to lend it to. Peer-to-peer (P2P) lending removes that middle step: a website matches people who want to borrow directly with people or institutions willing to lend. The UK Financial Conduct Authority (FCA) describes it as connecting people who want to borrow money directly with those willing to lend it, with the platform charging fees for arranging and managing the loans⁠^[1]. In the UK it is often called loan-based crowdfunding.

International bodies use a wider label. A 2017 report by the Committee on the Global Financial System and the Financial Stability Board defines fintech credit as credit activity facilitated by electronic platforms, noting that borrowers are often matched directly with investors, though some platforms also lend from their own balance sheets⁠^[2]. The same report found that in 2015 China was by far the largest fintech credit market, followed by the US and the UK⁠^[2].

#How does the money move in a P2P loan?

The details depend on the country. A US Government Accountability Office (GAO) report from 2011 explained the model used by the two largest US platforms at the time: a partner bank, WebBank, approved and funded each loan and then sold it to the platform, which paid for it with money raised by selling payment-dependent notes to lenders⁠^[3]. Each lender received a prorated share of the borrower's repayments of principal and interest⁠^[3]. Partnering with a licensed bank to originate loans is a pattern you will also see in banking as a service.

#Who carries the risk if a borrower does not repay?

The lender does. The GAO put it plainly: if borrowers fail to repay, lenders lose their principal and interest, because the risk of non-payment is transferred to them through the notes⁠^[3]. The FCA warns UK consumers that loan-based crowdfunding is a high-risk investment, that you could lose all the money you invest and that you will not have access to the Financial Services Compensation Scheme (FSCS)⁠^[1]. That is very different from a bank deposit, which is protected up to a limit; see how deposit insurance works.

The example shows two things. Spreading money across many loans makes the outcome less extreme, but it does not remove risk: a few defaults can wipe out the interest and more. The headline interest rate is not what you will earn; what you keep is the interest minus defaults and fees.

#How is P2P lending regulated in the US, UK and EU?

United States. In November 2008 the Securities and Exchange Commission (SEC) found that the loan notes Prosper Marketplace sold to lenders were securities that had been offered without registration, and ordered it to cease and desist⁠^[4]. The GAO reported in 2011 that the two largest platforms then sold their notes under registration statements filed with the SEC, which became effective in 2008 for LendingClub and in 2009 for Prosper⁠^[3].

United Kingdom. In June 2019 the FCA confirmed new rules for P2P platforms. Retail investors new to P2P who do not take regulated financial advice may not invest more than 10% of their investable assets, platforms must check whether the investment is appropriate for them, and platforms must have stronger plans for winding down if they fail⁠^[5]. Most of the rules applied from 9 December 2019⁠^[5].

European Union. The Regulation on European Crowdfunding Service Providers for business, (EU) 2020/1503, has applied since 10 November 2021⁠^[6]. It covers investment-based and lending-based crowdfunding for business financing, and authorised platforms can operate across the EU with a single authorisation⁠^[6]. Offers above €5 million over 12 months fall outside it⁠^[7]. Investor protections include an entry knowledge test, a simulation of your ability to bear losses and a key investment information sheet for each offer⁠^[8].

#What should a beginner check before lending through a platform?

Start with the basics: is the platform authorised by your regulator, what types of loan does it offer, what fees does it charge, and what happens to your money if the platform itself closes? The FCA's 2019 rules required stronger wind-down plans precisely because a platform failure can leave lenders waiting for loans to be collected⁠^[5]. Also check whether you can get your money out early: a loan runs for its agreed term, and selling your share before then may not be possible.

#How is P2P different from other fintech lending?

In P2P, investors fund the loans. In buy now, pay later and many embedded finance products, the provider or its partner bank lends its own or borrowed money and keeps the credit risk itself. For borrowers the experience can look similar, but for the people supplying the money it is a completely different deal.