Understand the Risks of P2P Lending Before You Invest

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Peer-to-Peer Lending (P2P) is slowly growing in Malaysia as an alternative investment option and funding platform for investors and businesses alike. We’re not quite at the level as China is – it’s the largest market for P2P in the world with over 1,000 marketplace lenders  – but over time P2P in Malaysia aims to address funding needs for SMEs. Currently, individuals are not allowed to receive funding.

According to a study by Lending Club (a US-based platform), 50% of millennials expect fintech to change financial services, and in fact, a percentage of them believe they won’t need financial services from a bank at all.

As an investor there are several benefits including you can get better returns than from a fixed-deposit account, you are free to choose who to lend to, you don’t need a lot of money to start investing, you can diversify your investments to receive varied returns.

See: Understanding Peer-To-Peer Lending in Malaysia

Several factors will, of course, determine the future of P2P in Malaysia, but let’s take a look at some of the risks you need to be aware of if you choose to invest in this platform.

What are the risks of investing in P2P lending?

You are not guaranteed returns.

This is probably the top risk involved. Borrowers may default on their loans and might not be able to repay their monthly dues to you. This leaves you at a total loss of your invested amount. Furthermore, P2P platforms do not guarantee loans, meaning that if the borrower defaults, they are not in a position to return your money to you. P2P platforms won’t pay you back from their own pockets.

This is where you need to understand your risk appetite, the risk grades of the businesses that are asking for money, and find one that you’re comfortable putting money towards. Manage your expectations. Although it’s tempting to go for higher-risk businesses, because of the higher interest rates and thus higher returns, you need to ask yourself what you can stand to lose if they default on their payments.

You could get scammed.

Malaysians tend to be quite trusting of others with their own hard-earned money. It’s important to stick to the reputable P2P lending platforms, especially the ones that the Securities Commission (SC) have provided licenses to. This guarantees that the platform you choose to go with is safe to invest with. Proper P2P platforms don’t actually hold your money within the organisation – all of the loan money is entrusted with an independent and licensed trustee, meaning the platforms have no authorisation over it. For instance, funds raised through Fundaztic will go directly into trust accounts managed by Maybank Trustees. Right now with only 6 licensed operators, we’re a little limited in options but do your research across all platforms before determining the best one to invest with.

A piece of advice? Go with the platform that gives you as much transparent information as possible. A lot of the time, you won’t know how the P2P platform handles the money at all. You shouldn’t be too quick to assume that all of them are trustworthy. If you’re serious about investing, at least find out how your money will be handled. Understand how they handle your funds and whether you are charged any fees that eat into the profit you receive.

It’s equally important for you to understand as much as you can about the business you are choosing to invest in. The beauty of most P2P platforms in Malaysia is the availability of information on the businesses including their business plans. This helps to give you a good idea of the legitimacy of the business.

You can lose a lot of money.

Because of how easy it is to invest on P2P platforms, it’s also incredibly tempting to put all your eggs in one basket. Maybe you have RM5,000 to invest and you see a great looking borrower, so you put all your money into that single borrower. If that business defaults, you’ve lost all your money. There really is no safety blanket so you do expose yourself to a lot of risks.

Understand your risk appetite and diversify your investments. Invest the RM5,000 across varied risk profiles and received varied returns. You can even try investing in the 6 different platforms.

You could be limited by the supply of borrowers.

Right now P2P lending is very new in the market and perhaps you won’t find that many borrowers on the platforms yet. This leaves you with a limited supply of borrowers to invest in. This poses a risk as you may not have as many diversified options to pick from and might be tempted to put the majority of your eggs in a few high-risk options.

Also called a “cash drag” effect, this is something that banks and financial institutions also have to contend with – there are times when the number of investors greatly outnumber the potential borrowers.

You open yourself up to liquidity risks.

You cannot demand that a borrower instantly repay its loan, just because you’re facing an emergency. You need to wait month after month, while the borrower slowly makes repayments. Your money is completely tied up throughout this period, so you must be sure you don’t need it.

It’s important to understand that P2P lending is not risk-free and though it is a very viable investment option, you still need to understand the risks involved so you can maximise your potential returns. Never take investment too lightly

Nadia Khan

About Nadia Khan

Nadia was a Content Manager at CompareHero.my. She has moved on to greater things but her words live on here.