Via P2P lending investing, individuals provide lending which is not established by banking frameworks, but directly to individuals, savers, and investors. All of them contribute to the development of alternative P2P financing. Investors put money in businesses, real estate, or trade finance while borrowers seek funds to finance their activities in the aforementioned sectors.
P2P lending does not take place through traditional banking branches, traditional investment, and credit rating structures. It is offered through controlled online platforms, where supply meets the demand for funds. For example, if a company is unable to raise the amount of the loan needed to execute its business plan through banks, it enters its details into the online P2P platform. It publishes its business plan, which includes the guarantees and returns it is willing to provide to the investor/financier. It also specifies the interest rate, direct equity participation, indirect equity participation using options (future fulfillment), or even a pre-agreed profit sharing until the full financing is repaid.
Being a lender on a P2P platform benefits you from the interest rate you will raise, which sometimes can be over 10%. This is a good percentage if you consider that there are no interest rates for the money you lend to the banks through deposits. By lending money to a P2P platform you are essentially earning a passive income. You borrow some amount (even 10 euros) and it is repaid to you with interest (even 15%). If you deposit 10 euros, you can be refunded 11.5 euros, and the higher the deposit, the better the return. Most P2P platforms have the buyback guarantee option, providing compensation to lenders in the event that borrowers do not repay.
P2P Lending Platforms
The original idea behind the first P2P lending investing platforms was to replace the traditional role of big banks. P2P introduced a pretty radical idea of removing the role of the bank as the intermediary between those who collect interest from their savings, and those who borrow funds. It is no coincidence that the trend began to become popular after the international financial crisis of 2008. After this period, many people lost confidence in banks and other financial institutions and began to look for alternative ideas.
The early P2P lending platforms were Prosper and Lending Club in the US, and Zopa in the UK. They started by connecting lenders directly to borrowers. This occurred in the same way that torrent platforms share files simultaneously from multiple sources to multiple recipients (hence the term “peer-to-peer”). Those who were interested in getting a loan applied on the platform of their choice. The platform evaluated their credibility and then brought them in contact with those who were interested in financing them, in exchange for an interest rate that they agreed on.
P2P was initially applauded as an instrument that could “abolish” traditional banking procedures. However, we would characterize it as a complementary investing tool that is gradually becoming apparent. With its own advantages and disadvantages, it can be used by banks, but also by large investment organizations, in order to approach markets of “money circulation”. It is essential that in Great Britain the Ministry of Finance allocated 100 million pounds for government grants to “non-traditional” funding channels, such as P2P lending.
In other countries, however, the institution remains completely unknown, as no initiatives have been taken for its adoption, despite the known inability of banks to finance the development of the private sector, especially in terms of small and medium enterprises.
It is always a matter of taking the risk
P2P lending has a much higher risk than ETFs. Do not forget that risk performance and high-interest rates go hand in hand. Started with Mintos in September with a small amount (1000 €) just for testing/project. It has an automatic investment strategy so you leave it and forget it, it has a buyback guarantee which does not fully guarantee you but from nothing it is something. It so far paid an average interest rate of 12% per year.
You know you are taking a risk so you need to be psychologically prepared to lose part or all of your investment. Our opinion is to have as your main investment something more mainstream (like the ETFs you mentioned) by making regular contributions there and if you can and want to, dedicate a small amount to “play” you can do so with p2p lending.
P2P Regulation and Compliance
The US and the UK are the oldest and most mature P2P lending investing markets. They have gradually tightened their operating regimes through the last years. In the US, companies have been subject to simultaneous control by the Security Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) since 2008, under the same framework as stockbrokers. In the UK, the Financial Conduct Authority (FCA) finalized its operating framework in 2019, designating them as alternative investment companies.
Lack of regulatory framework
In European Union, each country has a different operating regime. In most countries, there is still no relevant legislation. This lack of legislation prevents platforms from operating there (or forces them to operate illegally until there is a framework…)
However, the lack of a regulatory framework is the reason behind the rapid development of P2P lending platforms in the EU. These companies are pursuing an aggressive growth policy, attracting as many customers as they can. And they want to achieve that before governments pass laws to enact them under the supervision of financial authorities. This is why all P2P lending platforms advertise so many offers for new customers. Such offers include first sign-up bonuses and referral commissions. If regulators impose strict (and costly) operating conditions, platforms will have to deal with the following:
- capital adequacy
- check separation of own funds from third parties
- custody certification
- investor identification (Know Your Customer)
- credit assessment of borrowers and loan originators
- checks for laundering illegal funds
- impose different taxes based on the region.
Unlike bank deposits, stock investments, and insurance contracts, investors in P2P lending investing and crowdfunding platforms are not entitled to compensation. If a platform or loan originator goes bankrupt investors take the risk of losing the money they have invested. The only exception is to settle some compensation between the debtor and the creditors through litigation. This is similar to the case where an ordinary commercial company goes bankrupt.
To an extent, the risk depends on the platform you choose to go with
From the point of view of lenders or investors, P2P lending is also of particular interest. They choose between different forms of financing, at different interest rates or yields, in industries and companies of different maturity. The degree of risk is significantly reduced if the platform provides mechanisms for evaluating investments or financing. This mainly happens through electronic evaluation companies and corporate governance models.
