Peer to peer lending – just a fad or a change in the market?
| 27-03-2018 | treasuryXL |
Almost 2 years ago we reported that KNAB Bank had started a crowdfunding initiative to allow, mainly companies, to access an alternative area to fund their businesses, whilst at the same time allowing investors to directly participate in these loans and lend directly – via KNAB – to the borrowers. An extra incentive was that KNAB would directly participate in all loans – their role was not only as an intermediary and facilitator. Now is a good time to look back on their progress and refresh ourselves with the concept of peer to peer lending (P2P).
What is it?
It is an online service that matches the needs of the borrowers with that of the lenders. As the service is only related to lending and does not encompass traditional banking roles, the service providers are able to provide these services cheaper and more quickly than a traditional bank loan. The P2P service provider takes a fee – a margin on the interest rate and/or an annual service charge. In recompense, they enable the matching service to take place, administer the loan and ensure that the investors receive their money back – in the form of capital repayments and interest.
What are the features of the system?
- It is an online facility
- Intermediation is provided by the site owner
- Borrowers can post their proposals online
- Lenders can choose which borrowers and loans meet their criteria
- Repayment schedule is included
- Loans can be secured on unsecured
- Credit ratings are applied to the borrower
- Loans can be tracked and monitored for compliance
What role does the intermediary play?
- Process the loan applications
- Authenticate the validity of the borrower
- Perform relevant credit checks
- Process the cash flows
- Service the loans
- Ensuring correct compliance and reporting are carried out
What are the advantages?
As the service is an online matching service, it is fast, simple and cost efficient, This leads to lower interest costs for the borrower and allows investors to directly access the loan market and earn a higher return on their money than traditionally obtained at the bank. Also, the administrative processing time can be a lot quicker than by a bank. The system also can appeal to the ethics of a lender – they have the opportunity to directly help a company that is looking to expand or who require finance for major investment. Furthermore, an investor knows exactly who is borrowing their money – depositing money at a bank does not detail how that money is used by the bank. There has been a political and ethical backlash to banks over the last decade in response to the perceived domination they have within the market. As a lender, it is possible to get yields of between 5% and 9% on your investment. This will be lowered by the costs that the intermediary levy – KNAB take a service charge of 0.85% per annum on the outstanding balance.
What are the disadvantages?
As a lender your money is not guaranteed. You bear all the risks and, in the worst case, could lose your investment. Despite all the due diligence that has taken place before the loan request was placed on the platform, it is still necessary to perform your own checks on the potential borrower – your criteria may be different to that used by the platform. You cannot demand early repayment from the borrower – money that you invest must be money that you can miss for the duration of the loan.
How is KNAB doing with their P2P?
- They have arranged funding for 57 loans totalling EUR 9,125,000
- The average loan is for EUR 160,087, takes 49 hours to complete and charges an interest rate of 7.83% pa
- There are 4,533 investors with an average exposure for EUR 905 and a yield of 6.98% pa.
- All loans are based on linear redemption, have a tenor of between 6 months and 10 years.
- To date there have been no defaults on principal repayments and there are not payments in arrears.
- Participation can be from EUR 100 per loan – this allows for diversification.
Conclusion
For investors looking for an alternative investment with a longer duration, P2P can appear interesting. The risks are greater than depositing money at the bank, but the potential rewards far exceed the returns offered by banks. Additionally, for investors looking to approach the market more ethically, it does give the possibility of directly participating in someone else’s ambitions – knowing that your participation is having an effect on society. There are considerable risks, but these must be weighed up against the potential reward. Any investor needs to work out how much they can afford to lose on their principal investment against the higher return being offered.
