Peer-to-Peer (P2P) lending is a relatively recent financial innovation that has taken the lending market by storm and fuelled financial inclusion. P2P (peer to peer) lending originated in 2005 has evolved as a disruptive force in finance. The success of P2P platforms depends upon the availability of lenders and the ongoing measures taken by these platforms to safeguard the investors’ interests. Since the individuals investing their hard-earned money may not be savvy lenders, it is important for them to be aware of the risks associated with such investments. Certainly, risk vs. reward is a principal consideration for every investment decision, not only with the P2P market.
The most important every newbie should try to understand how the online P2P model works before investing money in it. An investor should be aware of how the money is invested on the platform and what are the risks involved. Do not hesitate to ask the P2P player about the overall volume, defaults, recovery process, and likely returns. You can do your own research or simply contact the P2P company through emails, chats or phone calls. In general, we could categorize P2P investment risks into 5 types: performance, platform, market, liquidity, and technology risk.
Although some P2P providers have put in place features to recover losses such as providing funds and asset security, there is a fundamental risk that a large number of borrowers default on their loans. A further performance risk exists when an investor's cash sits idle in their account waiting to be matched to borrowers.
The borrower may repay the loan before the end of the term and therefore the returns that could have been accumulated may be lost. Though in this case, the investor can simply invest in another loan.
Financial literacy describes the ability to make informed judgments and to take effective actions regarding the current and future use and management of money. It includes the ability to understand financial choices, plan for the future or spend money wisely. Financially literate people are equipped to make informed financial decisions about a host of money-related matters, such as:
- Banking and Bank Services
- Investing and building passive income streams
- Using and managing credit and debt
- Avoiding financial scams and exploitation
- Setting and saving for financial goals
- Long-term financial planning
- Estate planning
Diversification means spreading out your investment across multiple borrowers so that all your eggs aren't in one basket. This helps to average out the default rate and ensures only a small amount of your money is affected should a borrower in your portfolio fail to repay.
A number of risks exist at a platform level including insolvency, fraud, and security. If a significant platform was to fail, found to be fraudulent, lack of information presented, or if there was a significant cybersecurity breach, the market sentiment would decline.
If our trustworthy partners (loan originators) goes bankrupt, the investments would not be affected. All the transferred loans to the FAST INVEST will be administrated by FAST INVEST or the third party to make sure that the borrower will follow the terms in the Loan Agreement.
If a platform was to become insolvent the loan contracts between lenders and borrowers would still exist and contractually repayments should continue. FCA rules dictate that P2P platforms need to have a sufficient plan in place to ensure borrower repayments continue, independent of whether the platform is solvent or not. To a certain extent, this does protect investors, however, if a P2P platform was to become insolvent this would create significant turbulence for investors and its possible losses would be incurred. FAST INVEST does not keep investors money as its asset and all the investments are safe by loan agreement in the responsibility of loan originator. So in the unlikely case scenario, if our company goes bankrupt, investors will get all the needed information based on the database and procedure actions to be taken to keep the investments active. FAST INVEST investors should still receive the repayments from the loan originators and bankruptcy does not free the borrower or the loan originator from the obligations to our investors. Additionally, all investments are safe under a Money Transfer Agreement between all the parties (borrowers, lenders and FAST INVEST), so money would be transferred directly to the investor if FAST INVEST would not be capable of following the commitments.
Platform fraud is a significant risk to the sector. Essentially, platforms must deliver on their promises. In a bid to mitigate platform fraud the FCA stipulates that P2P platforms must hold client funds in a segregated client account, separated from their own operating cash. Regulators across the EU stipulate that crowdfunding or P2P platforms must hold the client funds in the segregated client account and not take the possession or control of the funds at any point, which eliminates the option for the platform to be fraudulent. FAST INVEST is fully compliant with the EU regulations.
Market risks relating to macro-economic factors that may affect the ability of a borrower to repay their loan or for the capital to be recovered post-default. Similarly to fixed-income investments, an interest rate risk also exists.
Borrower default may result from a poor initial credit decision or economic factors. Investors are advised to diversify across a large number of borrowers to ensure that the effects of one borrower defaulting are minimal on the overall investment. A large number of borrowers defaulting on their loan commitments remains a risk even after diversification.
P2P platforms create a marketplace for borrowers and lenders. Where an imbalance exists of more borrowers than lenders, investors' capital may sit idle waiting to be lent. This can significantly reduce returns. There may be higher demand from the investors than the supply from the loan originators resulting in investors' capital sitting idle to be invested and therefore reduce the returns.
On FAST INVEST the loans are published in EUR and in PLN, a person can invest in the currency of his/her choice and therefore may face the currency risk. It might result in losing or gaining profits. Any type of investment may have some risk, but FAST INVEST is doing everything to minimize it. Like currency risk - we can not effect PLN, EUR or any other currencies in the world. It is controlled by economy laws.
If interest rates were to rise, the interest rate paid by a borrower might not appear attractive in comparison to other forms of investments. For example, if Cash ISA rates were to rise to pre-recession levels of 5%, being locked into a P2P agreement which pays between 5-6% may not be worth the risk. With interest rates holding record-low levels since 2009, the P2P sector has largely grown in a low yield environment.
In the consumer lending space, if unemployment rates were to rise, the risk of borrower default would also rise. A rising default rate caused by unemployment would decrease investor returns and possibly lead to a loss of capital.
Investors are contractually obliged to lend funds to borrowers over the term of the loan. The inherent nature of lending is therefore illiquid unless the loan can be sold to a new investor. Depending on the P2P platform it may be possible to sell loan commitments on a secondary market or sometimes may be obligated to keep the investments to the term. FAST INVEST offers the MoneyBack guarantee using which the investors can sell the investments back to the loan originator and withdraw all the invested principal.
Similar to fraud risk, 51% of P2P platforms in 2015 regarded cybersecurity as a factor that could have a detrimental effect on the sector. Given that the entire P2P industry is based online, a severe cybersecurity breach is a real risk. Cyber attacks can have a detrimental effect on the platform if the one is not ready to defend itself. FAST INVEST blog recently published an article about the challenges of cybersecurity and solutions (technology) our platform is deploying. The weakest point in FAST INVEST security is the investor's password. So we advise first to create a unique long password with capital letters, numbers and symbols. In addition, you can find a useful article about identity theft and how to keep your personal data safe at our blog.
With the alternate modes of lending gaining prominence because of convenience, creativity and technological growth, P2P lenders are here to stay, widening their areas of services and offering tough competition to the traditional lending setup.
Do not forget, investing in the P2P lending sector can deliver risk-adjusted, predictable returns, however, there are unique risks that investors should be aware of. The illiquid nature of lending means investors should be prepared to commit for the term duration or be aware of the P2P platform's secondary market. Borrowers defaulting on their loans is an obvious risk that investors need to assess. However, further market and platform risks should also be evaluated when considering investing in the sector.