What would a Bank of England interest rate rise mean for RateSetter?
We are used to rising levels of speculation in the build up to the Bank of England’s decisions on interest rates. The next decision is due on Thursday, and there is a stronger expectation than ever that the Bank of England might increase the base rate for the first time in more than ten years.
Would it be good or bad news?
Our view is that an increase would be positive a sign of confidence in the strength of the economy and a step towards a more ‘normal’ interest rate environment.
It should be welcome news for the millions of savers across the UK if the banks part with tradition and pass the increase on to savers quickly and in full. It rarely takes long for banks to pass an interest rise on to borrowers though. Indeed, newspapers are reporting that banks and building societies have already begun withdrawing their cheapest mortgage deals and increasing interest rates for borrowers - in advance of the Bank of England decision. But banks are not obliged to pass on changes in the base rate. In fact, by widening the spread between the interest rate that they give to savers and what they charge for borrowers, banks traditionally increase their margins as interest rates rise.
While – if it is passed on to savers – an interest rate increase would be seen as a positive step, we know that its impact would likely be limited: savers will continue to see the returns on their bank accounts entirely eaten up by inflation.
The question we are asked more than any other is how our model will work in a higher interest rate environment.
There is no doubt that RateSetter has benefited from launching at the start of a sustained period of low and stable interest rates, because offering returns of 3.5 per cent in exchange for accepting some risk versus a 0.25 per cent with a guarantee of safety is obviously a hugely compelling proposition.
With interest rates on cash savings remaining close to zero and money held with banks declining in purchasing power due to inflation, the value of investing and accepting some risk in exchange for a return has been brought into clear focus. £2bn of lending and 450,000 customers later, we have built a track record of consistently delivering this value directly to our lenders and we believe that as interest rates rise our track record will ensure that customers judge us by value and understand that it is the premium over the bank rate that they look at not just the absolute difference.
Unlike the Bank of England (where interest rates are set by the nine members of its Monetary Policy Committee taking into account a range of economic data) and high street banks and building societies (where interest rates are decided by similar committees for whom a key consideration is the margin that can be earned between what savers are paid and what borrowers are charged), interest rates in the RateSetter market are set by the supply of and demand for money. We are committed to this model and it will always be a key feature of RateSetter.
RateSetter also narrows the gap between what lenders earn and what borrowers pay. The wider the banks make the gap between these two, the more opportunity there is for RateSetter to stand out by providing greater value to our customers.
In fact, RateSetter’s model is already operating in a slightly higher interest rate environment: RateSetter Australia opened in 2014, and has proved very successful, recently becoming Australia’s largest P2P lending platform by monthly volumes. In Australia, the base rate is 1.5 per cent. Peer-to-peer lending has thrived in this environment, and RateSetter Australia now originates AUS$12m in loans each week.
Now it’s worth noting that the financial environment in Australia is different to the UK in a few ways (for example, credit information on borrowers is harder to come by). However, this shows that P2P lending is not reliant on an extraordinarily low interest rate in order to thrive.
What would happen in the RateSetter market if the Bank of England increases interest rates?
An increase in the Bank of England base rate will lead to higher costs to borrow from banks and building societies, and as mentioned earlier, we are seeing this take effect even before the Bank of England decision. This should prompt more borrowers to shop around for a better deal and some of these borrowers could come to RateSetter.
RateSetter does not, and cannot, pass on changes in the Bank of England rate to either side of our market. But if the demand for money from borrowers increases, all other things being equal, interest rates in our market would increase. Therefore, although we wouldn’t have changed anything, it’s possible that a base rate change could indirectly influence market rates.