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New lending idea saves jobs and makes banks irrelevant

However much the banks claim otherwise, SME lending is almost paralysed. A small business owner has more chance of juicing cash from a turnip than tapping traditional lenders at present.

There is spare money out there, buckets of it, almost €13bn salted away in savings by last CSO figures. Even a fraction of that would fill the gaping credit void left by banks. But can people be persuaded to use their savings stash to back small business?

Peer-to-peer lending is about doing just that. It's a concept that has really grown legs elsewhere and appetite for it here among SME interest groups is keen.

Across the water in Britain online peer-to-peer lenders like Crowd Cube and Funding Circle give small firms a way to get funded through people who are fed up with low returns and high fees from banks and opt to put money into small stakes in companies instead.

To date peer-to-peer has been the domain of ordinary punters -- pensioners, students, tech fans who want to find the next Google, art aficionados who want to make a difference, hipsters who like the "collective wisdom of the crowd" concept, but more recently bigger investors are paying attention and the whole idea is scaling up to another level.

Funding Circle, which lends over €1m a week to SMEs, lifted its maximum loan limit from €120,000 to €300,000 at the start of this year, as bigger investor types began to pile in.

Meanwhile US peer-to-peer player Lending Club has hired former Morgan Stanley CEO John Mack as part of its drive to court the wealth management industry and get big financial advisers and broking houses to sell its offering to clients.

The Bank of England thinks this 'social lending' is the future. "Small peer-to-peer lenders like Zopa and Funding Circle could in time replace high street banks," its head of policy predicted.

British Chancellor of the Exchequer George Osborne has earmarked up to €120m in government funds to invest in peer-to-peer companies that lend to SMEs.

It has also caught the attention of the Minister for Finance, Michael Noonan. "It is one of a number of issues which is under active consideration by the Government to improve the financing environment for SMEs," his department told us. An online scheme matching private lenders looking for better options than bank deposits, and SMEs seeking funds together is actively being considered.

Here's broadly how it works: a software start-up or a jewellery design business owner or an artisan food exporter wants seed capital or expansion funding etc. Quelle surprise, the bank is uneffusive. He or she decides to give peer-to-peer a try.

The company goes through a credit vetting process before being allowed on to the peer-to-peer website. It is usually rated according to risk or creditworthiness. Funding Circle companies are rated from A+ (very low risk) to C (average) for example.

Then lender investors can bid on the amount and rate they want to lend for. The average loan is €50,000, but can be up to €300,000. The company gets the money within about two weeks.

Peer-to-peer firms say they are expanding at a rate of knots. Ratesetter tells us it sees this becoming a €12bn a year market in Britain, doubling this year alone. Funding Circle has lent almost €35m to date in its 18-month lifespan.

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It isn't happening here much -- yet. The Central Bank is wary of anything unconventional following the banking supervision fiascos of the past.

Michael Faulkner runs Seedups, a US, Ireland and Britain based peer-to-peer lender specialising in funding technology start-ups through a base of tech-savvy investors.

Seedups has €40m available in investor funds and over 1,350 entrepreneurs registered on site. Of these, 280 are Irish, 400 are British and 600 are US-based. Entrepreneurs can raise €25,000-€500,000.

Recently featured in the Forbes top 10 crowdfunding platform list, Seedups started about 18 months ago, inspired by Kickstarter, a US company that funds creative projects.

"I get approached all the time to invest so I thought the gap was there," Faulkner said. "We researched and identified tech companies as the niche to go for."

Initially the platform was designed with mainly Ireland in mind, but the recent passing of what has been dubbed the "crowdfunding bill" by the US Senate, aimed at making the funding of businesses via peer-to-peer easier, gives international scope.

"Since the bill passed everything's just gone crazy here," said Faulkner, who is in the US meeting VC firms in New York and Silicon Valley.

Where the typical peer-to-peer or crowdfunding model aims at any interested subscriber, Seedups restricts itself to high net worth investors that need to register specially, because of the level of legal and regulatory issues involved. Faulker did a lot of legal homework before setting up.

Patricia Callan of small business lobby group the SFA says a number of parties are trying to get concepts like this off the ground here.

"There have been a lot of suggestions from our members for credit solutions like this that don't involve the banks at all," she said. "A lot of business people would prefer to invest in other businesses than, say, property for example. It makes perfect sense for an owner manager and entrepreneur who knows the risks and they should be allowed to do it. There is certainly interest in it from people for pension options.

"The traditional forms of finance aren't working fluently across the world. We must tap more into people who have money and change the regulations to allow them to invest it."

What is it?

Peer-to-peer lending websites allow individuals to invest in companies in a quick and informal way. In Britain these sites lend €120m-€250m a year and rising. The two biggest players in the US lend over €400m between them. There is potential for €10m-plus of this type of investment in the Irish market.

The peer-to-peer lender charges a fee per transaction, but one typically lower than banks charge.

The pros

Investors can yield much higher return than banks or other options. For small business, it's a faster, more unfettered access to the funding they need and often can't get from their friendly banker.

Average yield with Funding Circle is 8.5 per cent a year -- more than double a savings deposit account rate -- though this doesn't include defaults. Default rates are between 0.5-2.5 per cent and are deducted from returns. Losses incurred can be offset against capital gains tax.

For businesses, the lending rate is competitive with banks (on average about 6 per cent) and far quicker and lighter on red tape.

The cons

The lender gets hit for any losses. One of the biggest (non-SME specific) British players, Zopa predicts that between 0.5-6 per cent of its borrowers will default. Investors are encouraged to spread their money over several companies to minimise loss risk.

Last year a peer-to-peer lender called Quakle collapsed when its systems failed.

There are legal and regulatory barriers to entry in Ireland, but momentum is growing to lobby for a change to this.

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