P2P lending – what are the risks?

 

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If you haven’t heard of P2P lending (or ‘peer-to-peer lending’ to give it its full title), then you’re missing out on a very 21st century way of borrowing, lending and investing.

 

P2P lending simply involves one individual borrowing from another, rather than from a bank or other financial services provider, although the process is usually mediated by a specialist P2P lending platform, often web-based.

 

But how risky is it to lend in this way? Here are some of the main stumbling blocks you could encounter:

 

Identity Fraud

 

The spectre of identity fraud has loomed large over the internet for many years now, and there are reasons to be concerned if you are engaged in P2P lending.

 

Fraud figures from CIFAS show that, in 2013, fraudulent loan accounts grew by a hefty 55%, whereas credit card fraud was up by just 24% and bank account frauds actually decreased.

 

If you are the lender on a fraudulent account, you potentially risk losing not only the interest you were expecting, but also the original sum you lent out.

 

Portfolio Uniformity

 

Portfolio uniformity (as opposed to portfolio diversity) occurs when you have invested in a very small number of loans, meaning failure to repay on the part of any one borrower will impact upon a larger proportion of your portfolio as a whole.

 

Unfortunately, this is naturally more likely to be the case with newcomers and small portfolio holders, as opposed to wealthy individuals treating P2P lending as a business.

 

As such, it is an unavoidable issue that undermines the very principles of peer-to-peer lending as a way for individuals to lend to one another.

 

Bad Debts

 

On the subject of bad debts – that is, P2P loan defaults – peer-to-peer lending platform Funding Circle uses available data such as credit history and company profiles to estimate the likely level of risk presented by each borrower.

 

It then categorises the debtors into five broad risk bands, with an estimated likelihood of defaulting.

 

The worst band, C-, presents a 5% risk of failure to pay, and creditors bidding to lend to such debtors are not allowed to offer an interest rate of less than 11.6%.

 

For the best borrowers, labelled A+, the estimated bad debt rate is just 0.6%, and they can borrow at rates as low as 6.0%.

 

Overcoming the Obstacles

 

Lending is inherently risky – CPA would not exist if there was not a need to pursue companies and individuals for non-payment of debts – but a diversified portfolio and careful adjustment of the interest rates you offer can overcome much of that risk.

 

It’s worth remembering that the UK government is among the lenders using Funding Circle, so this is by no means a niche business.

 

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