Money Insider: Seeking happier returns? Peer-to-peer worth a look

Many cynics said peer-to-peer lending would never work in the UK. But with savings rates from banks and building societies stuck firmly in the doldrums for the foreseeable future, there's growing evidence that this new sector is gaining traction.

With traditional savings rates having fallen by more than 40 per cent in the past 12 months, returns on offer from the peer-to-peer providers are looking more tempting than ever.

Compared with mainstream banking, peer-to-peer may still in its formative years with Zopa, launching as the UK's first such market place in 2005, but a continued lack of respect for the British banking sector and rock-bottom savings returns have seen the market flourish.

Zopa remains the biggest player, having arranged more than £367m in loans over the past eight years, and now has more than half a million members on its books. The projected return after any charges and defaults is currently 4.7 per cent.

Another key player in the peer-to-peer sector and acting as the middle man for individual savers and borrowers is RateSetter.

Launched just under three years ago, RateSetter may be considered a relative newcomer but has already matched more than £102m for its lenders and borrowers, with about £50m of this achieved in the last six months alone.

RateSetter currently offers a range of lending options (for savers), paying 3.3 per cent fixed for a one-year bond up to 5.6 per cent fixed for a five-year income bond.

It's not surprising that they are seeing a spike in business if you consider that the equivalent best buy savings bonds from the banks are paying just 2.03 per cent (Britannia) and 3 per cent (Shawbrook Bank) respectively.

There is even a monthly access account paying 2 per cent – and if you're a little nervous or unsure if this is right for you, you can dip your toe in the water and try it out with a minimum deposit of just £10.

However, consumers shouldn't see this alternative banking concept as a soft touch, as a strict credit scoring regime is absolutely vital to ensure defaults are kept to a minimum to give people confidence to continue to deposit their savings with the peer-to-peer companies.

RateSetter, for example, states that fewer than 15 per cent of loan applications were approved. So while it may offer a simpler and fairer way to borrow money, if you do not have an excellent credit profile, you are going to have to find your finance elsewhere.

One of the main concerns with people depositing their cash with peer-to-peer providers is that although the returns far outweigh those paid by the banks, they don't offer the cast-iron guarantee to savers that bank customers enjoy under the Financial Services Compensation Scheme. Even though tough credit scoring criteria are in place, there is still an element of risk, albeit very small, that you don't have with a bank or building society.

As long as you fully appreciate and are comfortable with this, lower overheads of not having to run a nationwide network of branches mean you can obtain better returns on your cash in the peer-to-peer market.

Providers have their own methods of trying to mitigate the risk to depositors. RateSetter, for example, offers a 'provision fund', which is built up from borrower fees, and reimburses lenders in the case of late payment or default.

This safety net has ensured that to date, every penny of capital and interest has been returned to every lender. Zopa now operates a similar model with its Safeguard feature.

Peer-to-peer is here to stay and, as long as providers keep rates com- petitive and bad -debt levels under control, the forthcoming regulation pencilled in for 2014 means there is every chance it will become an even bigger thorn in the side of the high street banks.

Andrew Hagger is an independent personal finance analyst from moneycomms.co.uk