Commercial Banks or Crowdfunding?

By Patrick Corby

crowd-fundingIn many parts of the world the international financial crisis reins on making loans tighter to acquire as capital regulation is restructured and growing concerns over defaulting becomes commonplace. But an alternative has been growing which offsets the traditional funding model associated with banks. Increasingly peer-to-peer lending, or crowdfunding, is gaining popularity in many different countries deciding to create a regulatory structure around the industry.

The UK government is currently working on legislation surrounding peer-to-peer lending in order to give the industry more legitimacy. Early next year a consultation will be held with crowdfunding websites in the UK in order to structure regulation and give the Financial Conduct Authority (FSA) supervisory controls by April 2014.

The service is not presently supervised by the FSA because it’s business model does not take deposits, it just matches lenders and borrowers together. This means there is no Financial Services Compensation Scheme; you could lose all your money. But due to screening, in the last 49-60 months Zopa a UK based site, has had a default rate of 2.2%; that’s pretty low. Andrew Giles, chief executive of Zopa, has stated that commercial banks which don’t disclose figures have default rates closer to 5% and upwards.

Seedrs, the crowdfunding website approved by the Financial Service Authority (FSA), include a online test to make sure consumers understand the risk involved in putting money in start-ups.

The framework will mostly involve assessing and screening businesses in order to avoid scams and also making sure that the risk of default for creditors in properly known. He USA has crowdfunding at the top of their annual investment scams list making regulation all the more necessary for the alternative financial model.

The Peer-to-peer association has stated “We have always strongly believed that introducing proportionate regulation was necessary to enable the sector to continue to flourish”

“We are committed to working closely with the government and the Financial Conduct Authority over the coming months to build the right framework for our future.”

A Growing Industry

Peer-to-peer fund-raising helps individuals and businesses raise the cash they need directly from members of the public. Entrepreneurs cannot expect to go to the bank and walk away with a loan, crowdfunding offers an alternative model.

Massolution, a research and advisory firm specialising in the sector, says that 1.2 billion euros ($1.6 billion) was raised globally from crowdfunding last year.

The movement towards crowfunding started in Britain in 2005 and spread quickly to the USA, Germany, China and elsewhere.

The USA has already legislated crowdfunding and Kickstarter a US based crowdfunding site estalished in 2009 now accept projects from the UK starting this autumn rivalling the UK’s Seedrs. China started to develop crowdfunding sites such as Ppdai.com starting in 2010 due to tight credit lending. Ppdai, which in Chinese is short for “lending through auctions” offers the legal top rate of interest of 23%, far beyond the benchmark rate.

There is a lot of scope for crowdfunding as a concept. Princeton University’s Ethan O’ Perlstein has already decided to try and fund a scientific methamphetamine lab in order to study amphetamines effect on the human brain. Starting a crowdfunding page on RocketHub on October 4th hoping for a project loan of $25,000. In return the research paper will be posted online for free.

“Together we can create an open model of scientific research and communication for the Internet age and beyond,” the team expressed.

Patrick Hussey at the Guardian gives a outline of civic crowdfunding to collect money towards state projects. This could become an alternative to taxation with ‘crowds, governments and companies coming together to fund projects’. The city of Portland already partakes in civic crowdfunding where those projects proposed get small, medium or large amounts based on a democratic lending ‘vote’ towards project individuals want to lend to.

The Bottom Line

  • Crowdfunding is a rapidly growing industry and provides a fierce alternative to commercial lending and interest rates.
  • The business model has already shook the foundations in lending, interest rates, scientific research, public projects and campaign funding.
  • Where will it head next?
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