P2P lending: Should I jump in?
In their quest for higher returns, Singaporeans now have a new option. They can deploy their funds through peer-to-peer lending platforms, a new type of financial intermediary, which uses technology to match borrowers with investors.
Also known as P2P platforms, these institutions allow lenders to advance sums directly to borrowers. The business that borrows funds, as well as the investor, can benefit. This is possible as borrowers who may not be able to obtain money elsewhere can obtain funds through these platforms. They may even be able to get a lower rate of interest than that which is available to them from traditional sources.
At the same time, investors can earn a return that is significantly higher than that available on a term deposit. P2P platforms function by disintermediating the banks. As the banking system is bypassed, borrowing costs come down while depositors get the opportunity to earn a greater rate of interest.
What is the rate of interest that an investor can earn?
An individual can expect a return of 10% per year or more if funds are invested through a P2P lender. Interest rates can be higher and returns of 20% are not unheard of.
A rate of 10%+ compares very favourably with the 2.5% to 4% return that is available on amounts invested in the Central Provident Fund. Bank term deposits offer even lower returns. A one-year term deposit in DBS Bank earns just 0.35% per year.
But the high returns that a P2P lending platform offers comes at a cost. There is no guarantee that you will get your principal back or even receive your interest on a regular basis.
A P2P lender’s function is to merely “introduce” the lender to the borrower. This is done electronically on the platform’s website. If the borrower fails to pay on time the investor bears the entire risk.
However, most P2P platforms offer their services to coordinate recovery efforts in case a borrower defaults. The costs of legal action and bankruptcy proceedings have to be borne by the investors.
MoolahSense – connecting investors with small and medium-sized enterprises
This Singaporean company offers Singapore-registered private limited companies and limited liability partnerships with a minimum annual turnover of S$300,000 the opportunity to raise funds on their platform. A credit review of prospective borrowers is conducted by MoolahSense before they are allowed to raise funds. This procedure could take as little as five days.
An investor can begin with lending just S$1,000. It is necessary to fund your individual account with MoolahSense before you can make an offer to lend your money on the platform.
The loan requirements of business enterprises are allocated using two different mechanisms:
- Auction process – The borrower sets a target amount and a target interest rate. Investors registered with MoolahSense can bid for a portion of the target amount at a rate of interest that is at or lower than the target rate. The last allocated investor sets the rate for the entire loan amount.
To take an example, a borrower may set the target interest rate at 10%. If each of five investors bid for a portion of the loan and the highest rate on offer is 9%, all the lenders will receive a rate of 9%.
- First-come-first-served – Every investor is required to bid at the target interest rate. The offer closes as soon as commitments for the target loan amount are received.
MoolahSense received a Capital Markets Services Licence from the Monetary Authority of Singapore in November 2016. As the platform is regulated by Singapore’s central bank, investors are assured of dealing with a reliable intermediary.
Investors have placed almost S$32 million through this P2P platform at rates of interest ranging from 15% per year to 25%. Capital Match allows individuals to lend to small businesses through its platform. The minimum investment amount that can be invested is just S$1,000.
In addition to loans, the platform provides small enterprises with invoice financing facilities. Invoices are discounted using funds provided by investors and an immediate payment of between 70% and 90% of the invoice value is made to the seller. When the company on whom the invoice has been raised pays, Capital Match arranges to repay the investor.
How does Capital Match make money? The platform collects 20% of the interest paid by borrowers as its commission. As with other P2P lenders, Capital Match does not guarantee payments and lenders bear the risk of default.
Should you invest through a P2P platform?
Before taking a decision to place funds with a borrower by using the platform provided by a P2P lender, an investor needs to ask several questions.
- Is the P2P platform reliable? Does it have MAS accreditation? How long has it been in existence?
- Does the P2P lender provide details about the default rate of borrowers who have obtained financing through its platform?
- Why is the borrower willing to pay such a high rate of interest? Is the firm unable to obtain financing elsewhere?
There is no getting away from the fact that these investments carry a high degree of risk. Even if you recover all your principal and interest over several lending cycles, your subsequent investments may prove to be unsuccessful.
If you are willing to bear the risk that these investments carry, it is advisable to take a few basic precautions. Allocate only a small portion of your investible surplus to this instrument. You should also diversify your risks by allocating funds to multiple borrowers instead of to just one or two companies.