P2P Industry Introduction: 5 out of 7
Do you want to be the boss of your own financial situation and make money by being an investor? The goal of this series of articles is to introduce you to P2P lending & crowdinvesting and to help you decide if this asset class makes sense for your investment portfolio!
Benefits of P2P Investing was the previous post of the series.
If you are considering P2P lending as an investment option for your money, it is important to understand both the benefits and risks of this asset class. Only then you can make an informed decision as to either crowdinvesting is a good choice for you.
In order to give you the negative perspective, learn about some of the key risks of P2P lending, which vary from platform to platform.
Short Background & History
P2P lending is a very recent investment activity that only got started around the time of the 2008 financial meltdown. The vast majority of the P2P platforms available on the market only appeared after that event. The question on how this type of investments and platforms will deal with the next recession cannot simply be known at this point in time. But what we do know is that when a recession hits, credit quality declines across the board.
Lack of Investors Protections
The great majority of P2P platforms are facilitators of the contact between a lender and a borrower. For most cases, any risk associated with lending to individuals or companies is solely taken by the individual lender. The P2P platform does not have or guarantee any protection on this.
No Transparency in Risk Assessment
It is very important to know about the risk associated with a particular borrower. All lending institutions undertake an exhaustive underwriting process to assess the risk in lending to the individual. But in most P2P lending investments, you as a lender, are in the dark.
While P2P platforms claim to follow a diligent procedure on this front, the same is not shared with the lenders. As an individual, you may never get to know the process followed by a particular P2P platform or the authenticity of the risk assessment. Also, the platforms do not share or give access to view the income or other documents submitted by the borrowers or the authentication process on the same.
Risk of Default
If a borrower is seeking to raise funds via the P2P platform, this means that they didn’t secure the loan through a traditional bank institution. In order to compensate for such risk, P2P lenders are awarded with high-interest rates. However, the possibility of default is always a risk. Another associated risk resides in the possibility of bankruptcy of a loan originator. This risk can’t be 100% eliminated.
P2P investing is working thanks to technology. Even though technological progress has expanded our opportunities, in all areas of life, there are risks associated with it. In the unfortunate event of a cyber attack, the operations will be terminated. So, it would be wise to choose the platform that has a strong IT team behind it.
P2P Platform Fraud – Ponzi Scheme
Some P2P platforms are simply frauds. In the case of a Ponzi Scheme, P2P lending companies raise funds from investors using false projects and borrowers. Instead of channeling the funds to truthful borrowers, the people behind the scheme spend them for personal expenses. The scheme then relies on funds from new investors to pay old investors. At one point, this scheme collapses because the people behind the scheme faces a liquidity crisis that makes them unable to deliver their promises to their investors.
In summary, are your investments in P2P lending safe? No! Even if some of the available P2P platforms are regulated by their local financial authorities and offer some protection for their investors and borrowers, when you compare this with the conditions offered to keep your money in a traditional bank account, there’s a much higher risk involved P2P lending investments.