Peer-to-peer lending - often abbreviated to P2P lending - is one of the terms used to refer to lending crowdfunding. It describes that mechanism whereby businesses and professionals can obtain a loan through an online platform and a plurality of people can invest small or large sums while receiving interest in return. 

In this article, in addition to explaining why there are different definitions (peer-to-peer lending, lending crowdfunding, social lending), we would like to summarize how it works, what benefits and risks it entails, and how it fits into the European ECSP regulation, now the main reference for those operating online in alternative business credit.

What is peer-to-peer lending and why it is also called lending crowdfunding

The peer-to-peer lending is a model first proposed in 2005 in the UK by the Zopa portal as a loan between private citizens mediated through an online platform. It is a model that eliminates traditional banking intermediation and allows people to lend money to each other, sharing the risk and receiving interest in return. In Europe, this consumer model pioneered a broader development: business loans financed by a multitude of private investors.

With this development, a second term has also become established, lending crowdfunding, today the more correct of the two in the European regulatory context. The two concepts coexist because they describe different phases of the same story.

Origin: peer-to-peer lending as a loan between private citizens

The first real peer-to-peer lending model originated in the UK with platforms such as Zopa (2005), which introduced an innovative concept: allowing private citizens to lend money to other private citizens without going through a bank, with the platform playing the role of technological intermediary and risk assessor.

The operation was simple:

• A private individual was applying for a loan for personal expenses;
  
• the platform verified income, credit history and reliability;
  
• Dozens or hundreds of investors were financing a portion of the loan;
  
• each investor received a share of the interest.

“Social lending” is an expression created to describe early forms of online lending between people, in which the “social” element was central: the platform connected private citizens who wished to lend or borrow money according to a collaborative logic, often perceived as more “human” and less bureaucratic than traditional bank lending.

In Italy this model today has almost disappeared: the main platforms of peer-to-peer lending or lending crowdfunding consumer have been acquired by banking entities and integrated into their lending systems. The result is that peer-to-peer lending in its original form is now a residual phenomenon in the Italian market, as reported by the latest report from the Crowdinvesting Observatory. Politecnico di Milano.

The evolution: P2P lending extended to enterprises

From the original C2C model, a second strand developed, which is dominant today: loans from private investors to enterprises, especially SMEs.

Here the logic is similar but the requesting party changes:

• applicant: a company that needs capital for a wide variety of purposes (cash flow, debt restructuring, specific projects, etc.);
  
• investors: individuals who finance the application by receiving an interest;
  
• platform: analyzes balance sheets, cash flows, risk ratings, repayment times to determine sustainability, risk level, and the interest rate of the transaction.
  

This extension had a decisive impact:

• Has increased the average volume of projects;
  
• made it possible to finance business ventures that were not served or served slowly by the banking channel;
  
• has turned P2P lending into a true tool of alternative finance for enterprises.
  

Today, for almost the entire Italian and European market, when we talk about peer-to-peer lending we refer to to this “business” form”.

The transition to the concept of lending crowdfunding

As the industry has grown, the term peer-to-peer lending has become too narrow to describe the variety of models and relationships that exist. Therefore, a new concept has emerged that is more consistent with the logic of crowdfunding:

lending crowdfunding = raising capital in the form of a loan from a multitude of investors (crowd) to a business or individual.

The term “lending crowdfunding” also makes it easier to bring this form of lending back into the fold of other alternative finance instruments that rely on raising capital online: equity and reward crowdfunding (to which we could add debt crowdfunding, a term, however, that is little used to talk about Minibond placement). The keyword “crowdfunding” unites, thus, all these instruments and makes them easier for the public to understand.

But also regulation. The ECSP Regulations, in fact, speaks broadly of “crowdfunding” as “alternative finance for start-ups and small and medium-sized enterprises (SMEs)” that can take “the form of loans or issuance of securities or other permissible instruments.”.

In the regulations, therefore, the correct wording becomes even more generic: “loan-based crowdfunding.”.

Operators, however, today agree to use the “lending crowdfunding” form.

How peer-to-peer lending works in practice

Peer-to-peer lending can work in two different ways, depending on the borrower: enterprise or individual. The technical structure of the platform is similar, but the operational logic, evaluation criteria, and areas of use change. Clearly distinguishing the two models helps to understand the evolution of the industry and the opportunities available today.

How the original p2p lending or lending crowdfunding consumer worked

The original model of peer-to-peer lending was the credit from individuals to individuals, in which individuals finance other individuals through an online platform. How does it work?

A private citizen applies for a loan for personal needs (e.g., purchase, liquidity, renovation, medical expenses, educational expenses). In order to apply for a loan, one must be of legal age and have a demonstrable income.
The process involves:

• Registration and identity verification (AML and KYC procedures).
  
• Credit profile analysis Through income history, reliability, any reports.
  
• Assignment of a rating Which determines the interest rate.
  
• Publication of the request On the platform, visible to investors.

Investors registered on the platform can finance part of the loan. The borrower repays the loan on an installment plan including interest.

How p2p lending from individuals to businesses or lending crowdfunding business works

Most European peer-to-peer lending (and virtually all Italian peer-to-peer lending) today involves loans from private citizens to businesses, especially SMEs.

The process is more complex than the consumer model:

1. Submission of the project application Through the platform.
   
2. Risk analysis based on balance sheets, financial ratios, business sector, debt, cash flows.
   
3. Rating assignment Through internal algorithms and qualitative assessments.
   
4. Publication of the project in the platform showcase, with detailed documentation.

Investors finance the enterprise with a share of the required capital and receive interest in return, in addition to repayment of the principal.

Reimbursement can be made according to two models:

• installment amortization (principal + interest each month);
  
• bullet (periodic interest and principal at maturity).

Advantages of peer-to-peer lending 

For investors, peer-to-peer lending represents an alternative form of investment with potentially higher returns than traditional banking products; for businesses, it is a quick, flexible and often easier channel for accessing credit than the banking system. 

Those who use lending crowdfunding as an investment tool find some very specific elements of interest:

• Yields potentially higher than bank deposits and bond products: the rate is commensurate with the risk of the project and is on average more competitive than traditional savings products.
  
• Access with small amounts: it is possible to invest from small amounts.
  
• Diversification: By investing small shares in various projects, the impact of possible insolvencies is reduced.
  
• Easy control: the investor chooses projects, consulting the risk and duration of the investment.
  
• Transparency of conditions: ECSP regulations require standardized information that makes it easier to compare different proposals.

One of the strengths of P2P lending compared to other asset classes is precisely the ability to create an extremely granular portfolio, adaptable to personal risk profile.

For a business, accessing peer-to-peer lending means using a Complementary (or alternative) financing channel to the banking system. There are five main reasons for this:

• Speed of obtaining capital: platform selections and crowdfunding campaigns are often faster than bank times.
  
• Access to resources even in the absence of traditional guarantees: the assessment model is often more flexible than the logic of bank lending.
  
• No sale of company shares: Unlike equity crowdfunding, the enterprise does not dilute the capital.
  
• Possible complementarity with other forms of collection: lending can be integrated into a broader strategy that includes other alternative financial instruments as well as traditional sources.
  

For many SMEs, lending crowdfunding is a way to finance growth cycles, production expansion or working capital needs without resorting to traditional bank debt.

Risks and limitations of peer-to-peer lending

Peer-to-peer lending is a useful and accessible tool, but it carries risks like all financial instruments. Understanding them allows you to assess whether this tool is suitable for your profile and to adopt more effective protection strategies. For a business that wants to do crowdfunding, it is also useful to know the risks from the investors' point of view, to put yourself in the shoes of your stakeholders and offer a truly attractive proposition.

Investors are mainly exposed to two categories of risk.

1. Debtor default risk

This is the most obvious risk: the company or individual who received the loan may not be able to repay it. Even with accurate rating systems, default cannot be eliminated. 

2. Poor liquidity of the investment

The invested capital remains tied up until the maturity of the loan. Unlike other financial instruments, there is no secondary market developed to resell the credit, so in case of need, getting out before the deadline is complex or impossible.

More varied, however, are the risks to businesses.

1. Reputational risk

Late payment or failure to repay can damage the company's reputation, exposing it to negative consequences in relations with customers, suppliers, and future investors.

2. Substantial costs

Depending on the rating assigned by the platform, the rate may be excessively high if the company is perceived as risky. In general, the average rate is higher than in the banking channel because the barriers to entry are lower and the transaction is faster.

3. Mandatory transparency

Lending crowdfunding requires a significant amount of public and verifiable information.

4. Strict time constraint

The repayment schedule must be adhered to without flexibility: it is not possible to “renegotiate” the maturity as is sometimes done with a banking institution.

Peer-to-peer lending taxation: a critical Italian issue

The taxation of peer-to-peer lending is one of the most relevant and critical aspects for those investing in Italy. In Italy, the Tax regime applied to lending crowdfunding returns is uncompetitive compared to that of other European countries. The reason is not only the relatively high tax rate, but also the way the tax system treats any losses, which cannot be offset as is the case with other financial instruments.

Understanding the tax framework is crucial to assessing net returns and to understanding why lending crowdfunding is much less successful in Italy than in the rest of Europe.

Interest received through authorized platforms is considered to be capital gains and should be taxed with a withholding tax of 26%. In theory, therefore, each time the investor receives a share of interest, the platform automatically withholds the 26% and remits the tax to the state. The investor then receives a net return already reduced by withholding.

However, not all platforms are licensed to operate as payment institutions or financial intermediaries, so many cannot act as tax withholding agents because they are licensed as crowdfunding service providers and do not have a suitable accounting structure and technological infrastructure to comply with the other required requirements. In this case, they have to rely on external payment institutions or leave the tax responsibility to investors.

If the platform May not apply the withholding tax of 26%, the investor is subject to a withholding withholding tax and must declare the interest in the tax return as “interest on loans or deposits,” with the relevant tax rules providing for tax liability to the normal IRPEF rate.

Not only can costs increase depending on one's IRPEF bracket, but it also increases the bureaucracy. And because most Italian platforms are not financial intermediaries or payment institutions, it creates an unfavorable environment for lending crowdfunding: a regulatory inequity that platforms are clamoring for the Internal Revenue Service to rectify.

Another weakness in the Italian regulations concerns how losses are treated.
Unlike other financial instruments:

• losses on P2P loans are not considered capital losses,
  
• and then cannot be offset With other capital or miscellaneous income.

This generates two main problems:

1. If a loan goes into default, the investor loses the principal without any tax benefit

There is no mechanism to recover a portion of the loss for tax purposes.

2. Amounts recovered after a default are taxed again

If a debt collection procedure collects a portion of the loan:

• the recovered amount is taxed again,
  
• despite being derived from previously taxed capital (through interest).

The 26% rate, therefore, would not be extremely high in absolute terms, but it becomes penalizing when combined with the inability of many platforms to apply it and the inability of investors to offset losses.

For this reason, for an Italian enterprise that wants to do lending crowdfunding, it is interesting to consider the opportunity to crowdfunding abroad.