The Peer to Peer (P2P) lending market has risen from zero, around 10 years ago, to an outstanding investment level of more than £8.7bn of loans in the UK alone.
Investors of all shapes and sizes are continuing to flock to the market, attracted by the prospect of a fair, risk-adjusted return on their capital and to beat the low rates offered from traditional sources.
However, among the eye-catching advertised rates and marketing initiatives, it’s critical that investors don’t lose sight of what really matters when it comes to P2P lending – loan security and the risk mitigation that this can provide.
In fact, you’ll find what differentiates the various players in the market is how they deal with loan security.
An obvious point perhaps, but the first thing to understand about P2P platforms is that no two operate the same model. Despite residing in a busy market-place, every platform takes a different approach to security, risk assessment and its lending processes.
While the FCA has set guidelines that all platforms must abide by, outside the core rules, platforms can take different forms of security on their loans.
The options for investors are substantial, and it can be both difficult and confusing for investors considering P2P for the first time to choose a platform that truly meets their needs for returns as well as their appetite for risk.
Therefore it’s important to understand what distinguishes platforms in terms of any security that they take and the credit criteria around this.
There are two key aspects to be examined in detail:
1) Pre-approval of loan: The checks put in place to ensure that high-quality loans are approved, where the loan can be afforded by the borrower but still recoverable in case one day it is not.
2) Post-approval of loan: The measures put in place to deal with loans defaulting and the recovery of capital in that situation.
Pre-approval of loan
Firstly, investors would be wise to check both the track record of a platform and also that of its team members. How long has the platform been established; how does that time compare to the average term of their loans; has long enough elapsed to see substantial repayments of loans or their defaults; what have been the default and loss rates to date?
Cautious investors might choose to be wary of recent entrants to the market without a track record, particularly if this comes with a new and untested credit model.
As with every sector, many new fintech businesses don’t survive their first year, and those that come in promising huge returns do so because of significantly increased risk factors somewhere in the model.
As is the case with all investments, high returns are commonly offered to attract people to higher-risk options. This could be because a platform is untested or because the loans themselves are high risk.