Why P2P lending is riskier than Cash ISA saving
Whilst many peer to peer platforms have performed well in delivering a healthy return to investors to date, such returns are by no means guaranteed, and lenders’ capital is at risk.
Each peer to peer platform has its own unique approach to risk measurement, control and mitigation. We cover these in further detail elsewhere on the site but for now, let us consider the main overarching risk considerations pertinent to all would-be peer to peer lenders:
1. Lenders’ capital is at risk and there is no FSCS protection.
In a regular UK savings account, the Government underwrites the first £75,000 of savings. This means that if your bank or building society were to fail, the FSCS would provide you with full compensation within the confines of the £75,000 cap. With a peer to peer platform, lenders do not currently benefit from this protection. Further, it is understood that there are presently no plans to include peer to peer lending within the scope of the FSCS.
2. Peer to peer lending platform failure
In many cases loans are made directly between borrower and lender, with the peer to peer platform acting as a facilitator. Thus, in the event that the underlying peer to peer platform/website were to fail for any reason, the loan itself is (theoretically at least) not effected. In the event that a peer to peer platform were to fail, it is possible that borrowers who have used the platform might cease to continue to meet their repayment obligations – resulting in losses for individual lenders. This consideration arguably compounds the risks associated with the lack of FSCS coverage detailed above.
3. Unlent funds may not collect interest
Whilst the peer to peer lending platform might be offering an attractive interest yield, the small print may include a clause which states that no interest will be paid to the lender on non-lent funds. It is likely that a significant portion of deposited funds will be lent almost immediately, however, in the case of larger deposits, the deposit may need to be lent out piecemeal over a number of weeks (or even months) if interest yield and borrower creditworthiness is to be maintained. If a lender wished to lend all of a large cash deposit from day one, he or she may need to accept a lower target rate of interest.
In any case, the platform may choose to only ever lend up to 80-85% of committed funds anyway, simply to allow a degree of borrower liquidity in the event that some lenders wish to terminate their loans early. The actual rate the lender receives may therefore differ from the quoted rate of interest – perhaps bringing a 10% quoted rate down to an 8% overall rate.
4. Taking your money off the table can be difficult and expensive
Peer to peer loans will typically be paid-down monthly, or perhaps quarterly, by the borrower. This capital repayment element, together with the interest for that period, will usually be paid net of any platform fees. If, however, the lender wished (for whatever reason) to withdraw their capital ahead of the agreed loan repayment date, he or she may need to bear (to some extent) some form of settlement cost – in effect ‘buying back’ their capital early. Retrieving capital quickly when it has already been lent out may even depend on their being sufficient liquidity within the platform – in other words, there may need to be sufficient quantities of other lenders seeking to ‘purchase’ loans at the time that the lender is wishing to ‘sell’ his or her loan portfolio. This may be facilitated by loan trading within the platform – which may allow Lender A to ‘sell’ some (or all of) their loan book to Lender B – however, platform fees (and an interest rate discount) may apply and are typically in the range of 0.5% to 1.0%. Such arrangements are often referred to as ‘secondary markets’ within the peer to peer platforms.
Updated: Monday, February 18th, 2019