Peer To Peer Banking - IELTS Reading Answers & Explanations

You should spend about 20 minutes on Questions 15-26, which are based on Reading Passage 2 below.

Peer to peer banking

In 1994 Microsoft's founder, Bill Gates, said that although banking is necessary, banks are not. At a time when many traditional institutions and ways of doing things are changing, banking is changing too. There are now new ways of accessing loans and lending money. Thanks to the rise of alternative finance, people can raise and invest money outside the traditional banking system and the regulations and rules that banks have to follow. This has taken many forms, such as crowdfunding, revenue-based finance and peer to peer finance. Crowdfunding is when specific projects raise money by asking a large number of people to invest a small amount of money in return for shares. In revenue-based finance, investors provide money to a company in return for a fixed percentage of the earnings. Peer to peer (P2P) banking also bypasses traditional banks by helping individuals give direct loans to other individuals. Prior to these financial vehicles, it was difficult to invest in new companies without having a considerable amount of money.

In traditional banking, an institution usually works as a financial middleman, regulating the transactions between lenders and borrowers. The banks check the financial status and credit rating of the lender and offer security to the borrower. A credit rating is a score given to an individual that measures how risky it is to lend to that person, based on a prediction of their ability to pay back their loan. P2P banking, on the other hand, works without the traditional checks offered by the banking system. The process is relatively simple. If someone is interested in borrowing money, they complete an online application form on a P2P lending company platform. The online P2P organisation assesses _the application and the credit rating of the person making the application. At this point, an interest rate at which the applicant can borrow money is assigned to them. When the application is approved, the applicant is given various options for borrowing and paying back the money and can choose among them. The interesting development here is that, depending on the platform, the investor and the lender are able to select their preferred client depending on the conditions that are on offer. The borrower then makes monthly repayments that include the added interest on the loan. The company that owns the online platform charges a fee to both borrowers and lenders for the services it provides and this is how it generates its profit - almost like a dating agency matching the suitability of the people involved.

Because P2P banks are online, they do not have to pay for a physical high street presence, which can be expensive. Nor do they need to have large teams of staff because lenders and borrowers are matched using a computer algorithm that assesses the credit status of each party. Consequently, the savings made can then be passed to their customers through better interest rates or reduced fees for their services.

Two indicators of the success of P2P banks are their wide customer base and the accuracy of their credit rating processes. P2P companies assess credit worthiness through their own artificial intelligence software, which takes hundreds or thousands of factors into account when someone applies for a loan. This process is done though analysing big data - the process of examining huge amounts of information to make decisions. The good news for P2P lenders is that so far, the number of bad debts has been relatively low. This is a key point in a process that relies on trust or the knowledge that if you lend money, you will get it back, plus more, after a period of time. This is significant because P2P banks do not have the same financial guarantees that governments require traditional banks to offer. They also do not have the same capital reserves that allow savers or investors to get their money back if the P2P bank fails.

The loan/investment model developed by P2P banks enables them to reach people who would not normally qualify for a loan from a traditional bank or who would not normally consider themselves to be an investor. For example, if a small business does not meet the narrow rules for borrowing from a traditional bank, they may be able to get a loan through P2P; and potential investors are finding the higher rates of interest attractive. Because of this, consumers now have more choice about where they invest and borrow, and traditional banks face a threat to their business.

So, what is the future for banking and P2P financial platforms? Possibly a lot will depend on the question of trust mentioned before. Big banks still have the advantages of large cash reserves, legal backing and government guarantees - all the safeguards not available to people putting their money into P2P banks. But for people with limited access to money and small businesses struggling to find financing, P2P lending is already changing the way people bank. Traditional banks will have to think about their response to competition from P2P banking, but for P2P companies the future looks full of opportunities in financial sectors such as insurance, house purchasing, loans for students, and so on.