Peer to Peer – Scale and Scalability

Anna Orlovskaya and Conor Sewell

Peer to Peer (P2P) lending is a hot topic at Fintech events and has received a lot of attention from academia, journalists, various international bodies and regulators.  Following the Financial Crisis, P2P platforms saw an opportunity to fill a gap in the market by offering finance to customers and businesses struggling to get loans from banks.  Whilst some argue they will one day revolutionise the whole banking landscape, many platforms have not yet turned a profit.  So before asking if they are the future, we should first ask if they have a future at all. Problems such as a higher cost of funds, or limited ability to scale the business, may mean the only viable path is to become more like traditional banks.

Present Scale and Profitability

P2P activity has now been around for over a decade. The fastest growth has been in China, followed by the USA and the UK (total new alternative finance provision in 2016: China – $243bn, US – $35bn, UK – £4.6bn). P2P lending platforms offer an online marketplace and depend on both the external supply of investment and the demand for loans. Currently, platforms lack product diversification with their revenue deriving from origination and servicing fees. As such, platforms are extremely reliant on continuously attracting and matching loans for investors and borrowers.

Despite having substantial lending volumes, many big UK and US platforms are still making operating losses despite their rapid growth.

Chart 1: Lending growth and operational losses of selected UK P2P platforms

Note: ‘Largest 3 platforms’ are Funding Circle, RateSetter, and Zopa. Figures are on a consolidated basis and include international operations. Loss data for 2013 excludes Ratesetter.

Sources: Cambridge Centre for Alternative Finance, Nesta, company annual accounts and Bank calculations.

In the following two sections we explore two ways in which P2P platforms could make money: first, by scaling up their existing business models; and second, by changing their business models altogether.


It may be that some platforms have made a conscious decision to favour growth over profitability for now, with a view to realising economies of scale. Central to this business model is i) whether there is sufficient appetite for the P2P investments and loans for the platform to reach scale and ii) whether their revenues can exceed the costs, even if they achieve higher scale.

Appetite for P2P products

P2P lending is still relatively young in the UK. As matchmakers, P2P lending platforms need to keep attracting new customers from both sides of the equation in order to grow. This is not a straightforward task: for example, supply of funds might be available but there might be lack of quality borrowers.  Or alternatively, they might have a slew of willing borrowers but are unable to tempt sufficient investors to finances them. A slowdown on either side affects platforms’ growth.

In the UK, P2P lending to businesses (mostly small to medium sized) is more substantial than to consumers. By contrast, in China and the US, P2P lending is mostly consumer focused.  On the supply side, retail investors have dominated the market, but the role of institutional investors has been increasing.

In the past few years, the market in the UK has been growing very rapidly, with year on year new lending growth in the region of 100%. But new data from the Cambridge Centre for Alternative Finance suggests that although activity is still growing, the pace of that growth has slowed down considerably.  In 2016, total new lending grew by roughly 50% in the UK and 20% in the US.

This, coupled with indications from some lenders that they are running into borrower constraints (i.e. their lending activity is being restricted by the low amount of potential borrowers), suggests that the traditional P2P lending model, that is widely used in the UK, may be reaching its limits. If growth rates continue to slow, platforms will find it more difficult to achieve the size necessary to fully realise their economies of scale.

One way that individual platforms may attempt to tackle this issue is through consolidation but given that the industry appears to be quite concentrated already (currently there are 3-4 major platforms that are key players), there might be only limited room for further concentration.  At the end, it may be that sustainable profitability may only be achievable with a few large lenders on the market.  Parallels can be drawn with other tech industries, where initially there were a number of players, but they gradually consolidated down to one or two market leaders (e.g. Google, Facebook).

Cost Structure

However, it might be the case that even following consolidation and hence larger scale, platforms still will not make money. For example, Uber is still unprofitable despite being a market leader on a large scale. And the two largest lending platforms in the US, who are dominant providers of P2P loans and several times larger than UK platforms, are also loss making.

The answer may lie in examining platforms’ cost structure more closely.  In theory, P2P platforms have operating cost advantages; they have no legacy costs, no requirement for branch networks and lower regulatory costs. At face value, these should be lower than for traditional banks. And, unlike traditional banks, these should be largely unrelated to scale- because, like other tech disruptors, their main cost is setting up and operating a platform. That opens up the possibility of undercutting traditional banks if platforms can achieve high enough lending volumes to overcome their fixed costs and realise these cost advantages.

But we must also think about the P2P lenders’ cost of funding- i.e. the interest rate they have to offer lenders to induce them to invest.  If this cost of funding is sufficiently higher, this could undo the advantage of lower operational costs. In reality, banks are able to borrow money at a lower cost, so even if P2P lenders have the slimmer cost base they may not be able to undercut banks, despite offering higher interest rates to borrowers.  Just scaling up might not be enough and some platforms may need to adjust their business model altogether…

Becoming a bank-like P2P platform

In the UK, P2P lending platforms have generally begun with ‘traditional’ or ‘pure P2P’ business models. But what started as pure and simple has been continuously evolving. Platforms have already been experimenting with new business models and techniques.

Some “P2P” platforms have had success operating a ‘balance sheet’ lending model. These platforms’ business model is not pure peer-to-peer lending, because the bank itself co-invest with investors, putting their ‘skin in the game’.  To do this successfully, such platforms tend to also concentrate on a particular lending market (e.g. property lending).

Other platforms might turn to traditional banking (one of the leading UK platforms is already applying for a banking licence) perhaps to diversify range of services they offer. For example, platforms will be able to offer FSCS-protected deposit accounts for savers and personal loans, car finance, and credit cards for borrowers, alongside their P2P products. Another reason is that FSCS protected deposits mean lower funding costs. Guaranteed deposits also mean that platforms can be listed on “best buy” comparison portals for savings account, creating a new potential market to tap for funds.

A natural question that follows – is there a fundamental difference for customers between banks and P2P platforms? The answer is not straightforward. Undoubtedly, platforms offer some distinct benefits for investors compared to banks– an opportunity to lend directly to businesses and retail consumers with relatively small amounts of investment, and achieve a higher rate of interest than is available from traditional savings accounts. On the other hand, banks offer deposits that are covered by the FSCS and so are less risky to P2P investors (although less risk averse investors might find that a better place to be on the risk-return trade-off).

On the borrowers’ side, there may be less differentiation. Our internal analysis (Chart 2) shows that interest rates on personal loans arranged via P2P platforms are competitive but not significantly lower than the rates available from banks. The exception is low-value loans (i.e. around £1-2k), where banks’ manual processes and fixed costs, make it uneconomical for them to compete.

Chart 2. Comparison of Zopa (leading P2P consumer platform) and bank consumer lending rates by size of loan (5 yr maturity)

Sources: Zopa’s instant rate estimator tool published on their website. The bank data come from the price comparison website Compare the Market. B6 banks are: Barclays, HSBC, Lloyds, Nationwide, RBS, and Santander.

But P2P platforms are not the only ones adapting. As P2P lenders start to become more like banks, banks are starting to become more like P2P lenders in some respects.  To counter the possible competitive threat from P2P lenders, banks have started to offer quicker and more user-friendly loan applications services (including quick, all-digital SME lending services). For a potential borrower, the difference between a P2P platform and a bank becomes less obvious. So, to stay in the game, platforms will need to compete for borrowers’ attention by offering a wider range of bank-like services.

Ironically, it might be the case that as much as the platforms have wanted to disrupt the banking model, they might need to turn towards it to grow and to achieve profitability.


Ultimately, the feasibility of scaling up depends on the balance of the two factors: a continuous appetite for P2P investments and loans, and whether the revenues can be higher than the costs when they do scale up.

The answer could be that platforms will need to consolidate and adjust their business models if they wish to have a significant and lasting presence in the financial system. A key part of this may be turning to banking: whether via partnering with banks or by offering bank-like services themselves. Peer-to-peer lending might be changing the world, but perhaps it will have to change itself first.

Anna Orlovskaya and Conor Sewell works in the Bank’s Capital Markets Division.

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Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.


Filed under Banking, Financial Markets

8 responses to “Peer to Peer – Scale and Scalability

  1. A first initial comment, but I think this blog somewhat mischaracterises P2P platforms. They are perhaps better described as “market place lenders” because the natural pool of investors — who want exposure to alternative loans and do not want the high margins and costs of traditional banks — are institutional investors not individuals.

    Another useful phrase, emphasing this perspective, is that of “alternative fixed income as an asset class”. Whether the platform supports direct one to one loan exposure, or is a balance sheet with equity and debt secured on a pool of loans or has a mutual fund participation in a pool of loans, is less important than investor understanding and seeking exposure to either small business, unsecured personal or other loan assets.

    On this basis a strategy of becoming more ‘bank like’ would be moving in the wrong direction, because it would be making it more difficult for investors to access this new asset class.

    That said, totally agree that the industry is still very young and that we will see evolution in business model (though they will remain diverse), consolidation is necessary, and co-operation with banks (as either sources of loans or as investors) is likely.

  2. Great post. Relative funding costs are undoubtedly one competitive challenge for P2P, but so is cost of acquisition, where traditional banks have a huge advantage from lending to their large captive customer bases.

  3. Andrew Wallace

    It’s good to see Bank Underground considering the future for P2P. It might have been fairer to evaluate the advantage that UK banks have had through being able to access cheap central bank funds, such as the Funding for Lending Scheme, which has closed only recently.
    It’s also worth noting that P2P investors know their funds are being lent for the medium term; in effect they are content for those funds to avoid the banks’ maturity transformation process.

  4. Robert Pearson

    Interesting article, but whilst it touches on the differences between P2P lenders and banks from a customer’s perspective, it fails to describe the fundamental difference between the banking industry and the P2P industry.

    In essence, the difference comes down to the fact that banks don’t lend money, they create money. The banking industry as a whole, doesn’t accept deposits and lend these out, which is what most people think it does. It does the opposite. Banks accept credit issued by one set of customers (in the form of mortgage agreements, loan agreements, overdraft agreements and credit card agreements etc), which become the banks’ assets and they thencreate their own liabilities in the form of deposits for another set of customers. It is these deposits that banks create that we use as a means of exchange – money.

    P2P lenders then persuade holders of these deposits to transfer them to the P2P lender, usually for a fixed period of time and the P2P lender will then lend these deposits on, by transferring them to a borrower, who then presumably uses them to purchase something, meaning the deposit continues to circulate within the economy. It’s worth noting that the same deposit can be transferred back to a P2P lender who can then lend it on again…and so on and so on. Effectively the P2P industry starts to look like the Fractional Reserve Banking model (albeit one with no reserve requirements), much beloved of finance textbooks, which doesn’t actually describe the modern banking system.

    Activity by P2P lenders has absolutely no effect on the quantity of money in the economy. P2P lenders simply recycle deposits after they have been created by banks. Conversely, every time a bank accepts a customer’s credit (which is erroneously referred to as ‘making a loan’), new money is created for that customer to use and every time a customer discharges an obligation to a bank (again erroneously referred to as ‘repaying a loan’), the money used to do that is destroyed. This doesn’t happen with the P2P sector.

    Once this is understood, it raises the question: what would happen if P2P lenders started capturing significant market share from banks? Well, the amount of money in the system would decrease. Alternatively banks might have to find new and possibly riskier sources from which they would accept credit in order to create new money at the same or slightly higher rate that existing money was being destroyed. Alternatively banks could undertake more lending to the government – either directly by purchasing more Gilts, or indirectly by the BofE purchasing more Gilts with newly created reserves (more QE).

    Whilst it is undoubtedly useful to examine the probabilities of P2P lenders being able to scale up and threaten to take significant market share from banks, it is also crucial to examine the effect on the banking industry and its vital role of creating money should this happen.

  5. Robert Pearson

    Reply to Andrew Wallace – it’s a bit misleading to talk about banks having access to cheap central bank funds, giving the banks a competitive advantage over P2P lenders.

    Banks can indeed borrow central bank reserves, the only source of which is the central bank which is the monopoly supplier of reserves. Central banks have always supplied reserves to banks on demand at a rate set by the central bank. Historically, banks would have to pay a rate somewhat higher than the central bank’s published policy rate (called Bank Rate in the UK) and any bank with excess reserves would have to leave them on deposit at the central bank at a rate somewhat lower then the published policy rate.

    Since QE, the BofE (and most other central banks) has had a policy of remunerating all reserves at Bank Rate flat and the BofE has introduced various schemes that have allowed banks to borrow reserves at Bank Rate flat, or slightly higher.

    But here’s the thing: Every single penny of central bank reserves created by the BofE (either permanent reserves created by the BofE purchasing assets, or temporary reserves created when lent to banks) has to remain on deposit at the BofE in the account of one of the roughly 200 institutions that have an account at the BofE. These institutions are banks (clearly), strategically important central clearing counterparties, some payment providers, foreign central banks and, of course, the Treasury. Banks are by far the biggest users and holders of reserves and most of the £480bn of reserves within the system, will be in the accounts of banks held at the BofE. Banks use reserves mainly to settle payments between themselves and also to settle payments to and from the Treasury. The banking system, as a whole, cannot borrow from the central bank and lend to customers – for the simple reason that banks’ customers by and large don’t have reserve accounts at the BofE (reserves can only move between entities with accounts at the BofE).

    It’s misleading to state that banks have a competitive advantage by being able to borrow from the central bank and lend those funds to customers. It doesn’t happen. It cannot happen.

  6. John Battersby (RateSetter)

    Thank you for posting this interesting blog. The way that we at RateSetter look at this is that we are opening direct access for everyday investors to similar quality loan assets that banks invest in, providing people with the choice to sustainably earn more on their money, in return for giving up the guarantee structure of a bank deposit.

    A bank pays its depositors a small return, but promises that their deposit will be kept safe. The bank pays a higher return on its long-term debt and equity. Blending these things together, our rough calculation is that currently a bank’s overall costs of funds is typically in the region of 3%. Or to put it another way round, on average, the providers of capital to a bank expect a blended return of around 3%.

    People investing via RateSetter are taking the same blended risk by investing in similar loan assets, and so logically should expect a similar return. At the moment, RateSetter investors are looking for an average of 3% to 5% depending on the level of access they require to their funds. The explanation for the premium of up to 2% is that they are investing in a relatively young system which is still building its track record. Over time, we expect this premium will continue to reduce as P2P platforms like RateSetter prove our ability to manage credit cycles and are seen as durable businesses. The blended cost of funds will become similar, with the difference being that whilst a bank pays depositors a small return with a view to paying its equity providers a larger return, RateSetter investors all enjoy the same blended return. This is why we believe P2P is a positive and sustainable development for investors.

  7. Both P2P and Banks have the same basic problem in generating volume from customers whose credit ratings are low because their income is low, which is why they are in the market in the first place.
    The Banks have low demand for funding big ticket investments as those customers can’t see where demand for the output will come from.
    The common thread is the lowest ever wage share of GDP. The economy is sputtering on the fumes from an empty wages tank, siphoned by hegemonic shareholders.

  8. Robert Pearson

    In reply to John Battersby:

    Whilst you are correct to state that bank depositors receive a lower return because bond investors, subordinated bond investors and equity investors demand increasingly higher returns, you neglect to state the reasons why there is this spectrum of returns.

    Ratesetter investors enjoy the same blended return but also shoulder the same, blended risks that the assets they invest in default. With banks, there is a spectrum of returns because there is a different level of risk assumed by investors on each point of that spectrum.

    Depositors receive the lowest returns, but they have next to no risk of loss. Conversely, P2P investors should expect to lose a (hopefully) small proportion of their principal investment every year.