Over recent years, a range of fintech (financial technology) challengers to Australia’s traditional banking sector, dominated by the four big banks, have emerged. Smaller, nimbler operators harnessing the power of new technology for financial transactions are disrupting the big banks, including peer-to-peer (P2P) lenders.
What is peer-to-peer lending?
Banking always involves money from one group of customers (savers) being transferred temporarily to another group of customers (borrowers).
What separates out P2P lending, also referred to as ‘social lending’ or ‘crowd lending’, is that it facilitates an individual obtaining a loan directly from one or more other individuals. Banks are cut out of the process, or ‘disintermediated’.
How it works
Imagine two individuals, Adam and Steph. Adam has $400,000 to invest and would like to get a decent return. He could put the money in a savings account, but the interest he receives will be negligible and he worries that shares are too risky.
Steph is a small businesswoman who needs $400,000 to scale up her business. She’s applied for several bank loans but, despite the fact her business is doing well, she isn’t able to get a loan as she doesn’t own a home.
Wouldn’t it be great if there was some sort of website that allowed Adam and Steph to make contact?
Well, there are now lots of these websites provided by the likes of Society One, MoneyPlace, RateSetter, Harmoney, ThinCatsAustralia, OnDeck, Bigstone, Marketlend.i
The Uber of lending
Just as Uber and Airbnb do, these P2P lenders provide the platform that facilitates transactions taking place and take a cut of the action – from the borrower, lender or both – in return. SocietyOne, for instance, has revealed it takes a commission fee of 1.25% per annum from the interest paid by borrowers on its platform.i
In practice, loans facilitated by these P2P lenders are often more complex than the one-on-one transactions described above. An individual borrower may borrow from several lenders, just as an individual lender may lend to several borrowers.
Just like a bank, a P2P lender will perform a credit-history check on potential borrowers and assess their repayment capacity. But it’s a case of caveat emptor for lenders, who bear all of the risk on what are usually unsecured loans. The P2P lender charges a commission or fee if the loan is repaid, but it doesn’t provide lenders with compensation if it isn’t.
The industry is still in its infancy and most Australian P2P lenders are private companies, so there is not much solid financial data available. However, the Australian Securities and Investment Commission (ASIC) reports P2P lenders wrote $433 million of loans in the 2017-18 financial year.ii Australia’s first and largest P2P lender, claims to have facilitated $800 million in loans and to be on track to hit $1 billion by 2021. iii
What’s the catch?
Whether you are a fintech lender or a traditional bank, the issue with lending money is that you may not get it back. This is why banks are so reluctant to give loans to those without a property or other assets they can sell off if things go pear shaped.
Those who bypass banks and use P2P lending platforms are playing a high risk/high return game. While Adam won’t get much of a return if he puts his money in the bank, he needn’t worry about losing any of it.
Steph will probably find it easier getting the money she needs through a P2P lender, but there’s a trade-off. She’ll have to pay a higher interest rate and hefty penalty fees if she misses any repayments.
Proceed with caution
While Australians may want more choice than has been provided by traditional banks, it’s worth remembering that banks offer more safeguards than some of the newer entrants, such as the government guarantee on deposits. In the current market turmoil, safety and certainty are highly prized.
As things stand, P2P lending involves significant risks for both lenders and borrowers. If you need to invest or borrow money, please give us a call to go over your options before you act. 03 5434 7600.
i https://www.canstar.com.au/p2p-lending/who-offers-peer-to-peer-lending-in-australia/
ii https://download.asic.gov.au/media/5074452/rep617-published-12-april-2019.pdf, page 5