Peer to Peer, or ‘P2P’, lending is a method of bringing borrowers and lenders together without a traditional financial institution to act as intermediary. This increasingly popular form of lending takes advantage of the internet to connect individuals who have money to lend with those who require funding for any reputable need.
It’s not an entirely new process. The first P2P lending portal was Zopa, founded in the UK in February 2005. In the past 11 years Zopa has processed loans worth more than 1.5 billion pounds. However, this figure pales in comparison to the two largest US services. As of March 2016, Lending Club and Prosper have processed loans of more than US$18 billion and US$6 billion respectively. In Australia the industry is comparatively small at this stage. If Australia follows the global trend, this will grow rapidly. For instance, Morgan Stanley estimates that by 2020 the global P2P market could be worth up to US$490 billion.
There is a number of P2P lending methods currently in operation and more variations are continually being dreamed up.
How does it work?
A typical P2P facility involves a website, known as a ‘portal’, that lists potential borrowers, the amount they are seeking, the term of the loan, the interest rate which they hope to pay, and the intended use of the funds. Lenders negotiate with borrowers to come to a mutually acceptable agreement and the loan is made.
Some portals use an auction system with lenders competing to win loans by offering the lowest interest rate. This can allow borrowers to obtain loans at below traditional lenders’ rates.
The ability to directly match borrowers and lenders on a supply and demand basis makes the P2P system a perfect marketplace – ASIC refers to the concept as ‘marketplace lending’.
Other uses for P2P
Peer to Peer lending is commonly known as ‘social lending’ due to the intent of some lenders providing funds to borrowers who have worthy causes but are unable to obtain loans from traditional sources. This category includes microfinancing which involves making very small loans where a small sum of money would have a large impact, such as to budding entrepreneurs living in third world countries.
Skilful lenders can also use P2P sites as a means of investing by building up a portfolio of quality P2P loans.
Is it safe?
The safety of lenders’ money is an important issue and as loans are generally unsecured some portals will rate borrowers using their own credit rating systems. Governments around the world have introduced a variety of regulatory regimes in order to police P2P lending. In the US, the Securities and Exchange Commission requires P2P portals to register their loans as securities. ASIC treats the facilities differently depending on their method of operation. Some portals act simply as a marketplace to match borrowers and lenders. Others pool lenders’ funds prior to making the loans and these are regulated as Managed Investment Schemes.
Peer to Peer lending was once classified as ‘fringe finance’, but all signs point to it becoming a major source of funding for people from all walks of life for a multitude of purposes.