People who are new to investing often prefer to invest in one of the savings products offered by banks, but investing in a bank is never a profitable exercise. Interest rates are at an all-time low – plus banks never have been one to share their “fortunes”.
These days anybody who is into investing must have heard of Peer to Peer (P2P) lending. It has gained a lot of popularity in recent years.
Peer to Peer lending is not something new. P2P started in 2005 with the launch of Zopa, the first peer to peer lending service. Though Peer to Peer lending was the signal of the financial revolution, it was the 2008 recession and the ensuing “credit shortage” that showed the chinks in the bank’s armours and pushed peer to peer lending into the limelight.
At its inception, peer to peer lending was quite simple. The P2P platforms were simply a place for borrowers who were looking to refinance existing high-cost debt facilities and on the other hand were people who wanted to earn higher interest on their savings.
Peer to peer lending has now grown into a worldwide industry. The size and number of lending platforms have rapidly grown. P2P platforms have now evolved and do not just offer loans for consumer lending. Peer to peer lending platforms is giving banks a run for their money by offering tailored products for home financing, students loans, franchise financing and loans to SMEs to name a few.
 

What are the risks of investing in peer to peer lending platforms?

 
No business is without risks and the same holds true for banks and peer to peer lending. The 2008 crash made it very clear that even giants can fall, however having said that, it is important to remember that reducing risk to acceptable levels is one of the prime objectives of any successful business.
So is peer-to-peer lending a risky business? Should you invest your savings in peer-to-peer lending?
There are many platforms for investing in Peer-to-peer lending. Each platform has its own way of conducting business and therefore a different approach to managing and mitigating risk.
Let us delve into greater detail of how risk is managed with examples.
 

Zopa

 
Zopa lends money for personal loans to “reliable investors”. Zopa checks all of its investors by checking their credit histories, personal income and Zopa also has a requirement, making it mandatory that the borrower should have had a UK address for a minimum of three years. This is the first stage in risk minimization. Lend money to people who are very likely to pay back.
The second stage of risk minimization is figuring out how to minimize the impact of a bad debt.
Firstly, any investment made is divided into microloans and only a maximum of 2% of investment is lent to one single borrower. This ensures that a bad debt will not wipe out a major chunk of investment.
Secondly, what happens if a major default does occur? Firstly it is Zopa’s responsibility to chase down bad debts. The bad debts are assigned to “Safeguard trust”. First priority is to chase down bad debts. If the debts are truly irrecoverable then Safeguard maintains a fund to cover bad debts. The fund is generated by contributions from members. Currently, Zopa’s fund has a 10% buffer meaning the fund has 10% more money than what Zopa expects to pay out.
Investing in Zopa is quite low risk. Their actual bad debts have always stayed lower than their predicted percentages. And it is not that the predictions have a buffer built in them. For 2015, Zopa estimated 2.88% of the loan value to go into default, however, the actual percentage was only 1.01%.
 

Rebuilding Society

 
Rebuilding Society is at the other end of the spectrum from Zopa. Rebuilding society lends out to businesses. Rebuilding society does not have a provision fund. However, to cover risk it has two operational policies in place. They are:
 

• All loans are to be backed by securities. Businesses applying for loans under $50,000 have to give a personal guarantee. Loans at $50,000 or above are secured against assets.

 

• You cannot provide more than $2,000 to one business.