P2P Lending Platforms Are Riskier Than Many Realise – Or Are They?
Peer to peer lending has given hope to consumer savers who are seeking a better return on their money. However, it may be perceived as a riskier form of investment.
Are the new generation of crowdfunding platforms that have followed peer to peer lending far more dangerous than many have imagined? ‘Dangerous’? I would say perhaps riskier, yes but then again it potentially offers higher returns so it’s down to the appetite of the investor’s level of risk!
The Financial Conduct Authority (FCA) is planning to crack down on these crowdfunding platforms to protect investors who do not know the risks with tighter and new regulations to be implemented if platforms fall short of its requirements to be “clear, fair and not misleading”.
Loan-based peer to peer platforms function by lending money from usual (consumer based) savers to people and small business entities, removing the middlemen such as banks, and offering both parties a healthier rate.
Savers have been gaining interest rates of 5% per annum or more. But this sort of lending does come with a level of ‘danger’ more than just putting it in a standard savings account.
Meet your peers
As an example, there are two well-known platforms are Zopa.com, which has acquired £1.89 billion from investors since 2005, and RateSetter.com, which has taken almost £1.6 billion since 2010.
Although their interest rates have dropped recently, Zopa still pays a variable 3.1% while RateSetter pays 2.9% (please check their websites for the latest rates and terms and conditions).
The rates in peer to peer lending are higher than you can secure on the high street. However, crowdfunding platforms offer even more appealing returns which can range from 5% to 15%.
These are known as equity-based platforms and selling you a share in perhaps riskier and unsafe start-up businesses. Hence, even though you can gain a return if they do well, you can incur big deficit if they flop.
If you deposit your cash in a building society or in a bank, the advantage is that you are protected under the Financial Services Compensation Scheme (FSCS). FSCS fully covers the first £85,000 of your investments.
But with peer to peer lending, you don’t get the same protection, which only means your investment is at a much greater risk.
Zopa and RateSetter lessen the danger by spreading the investor’s money out between scores of approved and assessed borrowers making their own multi-million pound contingency reserves to refund potential losses.
“The FCA found that client money handling did not always meet the necessary high standards,” Mike Gordon, technical director at IFAs Rutherford Wilkinson, stated.
Gordon continues to caution that several crowdfunding platforms have far less protection:
“More savers will be lured in once the new Innovative Finance Isa which started earlier this year, with promises of rates between 6% and 8% a year.”
“Investors should approach with caution until firms have improved their standards.”
Hannah Maundrell, editor-in-chief of Money.co.uk, says peer to peer platforms need a strong contingency plan so savers do not lose money if the firm goes into default: “They will also have to carry out more thorough checks on borrowers.
“Some do, but the FCA’s rules could make it compulsory.”
Additionally, Maundrell says one should not match up returns on a peer to peer lending platform to the interest rate on a savings account.
“They are different beasts. Not all P2P platforms are equal and you need to check where your money is going and what happens if something goes wrong.”
Maundrell says it’s okay to consider crowdfunding platforms if you know the dangers.
Neil Faulkner, managing director at 4thWay, says risks are unavoidable if you want higher returns on your investments.
“If you can accept this, spread the risk across several established, transparent P2P lending sites that have a proven history, such as RateSetter, Zopa, Landbay.co.uk, LendingWorks.co.uk, and PropLend.com.”
So, the answer ends with the level of risk the saver or lender feels they can manage. This sort of investment are always going to be perceived as full of risks and this is just another product to cap a gap in the lending market when the banks chose to pull out.
You certainly need to assess your own comfort and understand the psychology to risk before taking action and the best place to start would be seeking independent financial advisor (IFA) through an authorised FCA entity.
However, make sure your IFA is fully up to date and knowledgable about peer to peer lending and crowdfunding platforms in order to correctly assess your needs and give a true balance to risk.
If they can, then I ask the opening question in the title above…