Guest article: How safe is peer-to-peer lending?
Peer-to-peer lending has seen phenomenal growth over the last 11 years and its steady, non-volatile, relatively low-risk returns are proving understandably popular with disgruntled savers and worried stock-market investors. I want to explain what makes it intrinsically lower risk than the stock market and share some of the figures that back that up.
There are over 150,000 active P2P investors, according to the Peer-to-Peer Finance Association (P2PFA) - which represents the bulk of the industry.
The collective banking experience in the association’s eight member platforms is impressive, which shows in their performance: the vast majority of investors who have sensibly spread their money across lots of loans and lent their money regularly have not lost money. Some platforms even have a perfect track record of zero losses.
That's a combined 42 years and £6 billion lent at these platforms, half of which has already been repaid.
Of the 11 non-P2PFA platforms for which 4thWay has enough data, investors have easily recouped low losses at nine of them through the interest they've earned. Of the other two platforms, investors have performed worse but will still have been somewhat unlucky to have made a loss overall. There has been just shy of £800 million lent through these 11 platforms.
The provision funds and interest-rate buffers that are in place to protect against losses during recessions look impressive. Historical annual returns at all P2PFA platforms range between 3.5% and 10.2%, after both lending fees and bad debts, for investors choosing to lend and re-lend for longer periods. Reserve funds generally add two to three percentage points of protection, which sounds small but is actually moderate or large.
When 4thWay conducts the same "Basel" stress tests on these platforms as we have done on the banks for many years, they come out looking good. And we test far more strictly than the banks are required to do.
Our test results show that even during a severe, 1-in-100 year recession or property crash of 55%, we expect investors to make back their losses within three years - if they experience any losses at all.
Some platforms have shut down due to not attracting enough investors and borrowers. Based on the information we’ve seen, most investors here have still got all or most of their money back - plus interest. The future might not always be the same, but it’s a reassuring sign.
When lending is done appropriately (as opposed to the crazy, sub-prime, complex structured lending that even the banks themselves don’t understand), P2P is intrinsically lower risk and more stable than the stock market, not least because lenders are higher up in the queue for what’s left when a business or individual borrower goes bust.
Investment research firm Liberum found that US credit cards and UK personal loans have made money for the banks every single year for the past 20 years - through recessions and crashes.
Now the transfer of skills from banking to P2P has led to a new form of investment with a similarly attractive risk profile to bank lending itself. Indeed, Liberum tested two major P2P lending platforms and reports they’ve had better results than the banks.
Tips to lend more safely
Look for platforms with people who have lots of underwriting and credit-risk experience in the specific types of loans the platform does.
Look for simple-to-understand, low-risk lending.
Spread your money across lots of loans. [Note from RateSetter: we do this automatically for you!]
Don’t lend till you’re confident you’re making a great decision. Otherwise, during a recession, panic or crash, you’ll just pull your money out at the wrong time, and the market might penalise you for doing so.
Next step: learn how to track platforms to ensure they're maintaining their standards.
Neil Faulkner is CEO of 4thWay, the P2P lending ratings agency.