What is Peer-to-Peer Lending?
Peer-to-peer lending, is also known as P2P lending. It is essentially loan of money to individuals or businesses through an online marketplace that matches between the lenders and borrowers. Borrowers are typically individuals seeking for personal loans or businesses sourcing funds for the purpose of working capital, expansion, etc. Lenders are generally investors who seek to earn passive income in the form of interest associated with the loans principal lent out to the borrowers. The peer-to-peer lending platform facilitates the loan transactions by connecting the borrowers directly to the lenders and earns money by charging origination and servicing fees. I supposed now you will have a better idea on what is peer-to-peer lending before we delve into further details including both pros and cons to the borrowers and lenders.
The offerings on peer-to-peer lending may differ in terms of the loan tenure, loan size and interest rate focusing on different target markets. Nonetheless, all peer-to-peer lending platforms in essence operate based on the same principle model. It does not involve a financial intermediary such as a bank or financial institution in contrast with the traditional borrowing and lending activities. The emergence of peer-to-peer lending has set the scene in the revolution of finance services industry. Zopa Ltd. started out in the U.K. in 2005, the same year Prosper Marketplace Inc. formed in the U.S. Lending Club was founded a year later. It has since gained popularity over the past decade with significant increase in market size globally. According to Allied Market Research, peer-to-peer lending market is expected to reach $460 billion by 2022 at a CAGR growth rate of 51.5% from 2016 to 2022.
Pros and Cons of Peer-to-Peer Lending
There are various reasons explaining why peer-to-peer lending is so captivating to both the borrowers and lenders. This is because such business model provides a win-win formula to both parties that fits their interests impeccably. However, the model also underlies some risks and downside that both parties may fail to observe. Let’s look at some of the pros and cons of peer-to-peer lending from both borrower’s and lender’s perspective:
Borrowers – Pros:
a) Simpler and speedy process
Peer-to-peer lending eliminates the needs of stringent and cumbersome processes based on the banks or financial institutions’ practices. Consequently, borrowers can raise funds conveniently with ease.
b) Lower eligibility criteria
Peer-to-peer lending generally has lower credit requirements as compared to the banks in particular to borrowers who do not possess good credit scores.
c) Lower interest rates
Borrowers have the opportunities to bargain for competitive interest rate when the lenders bid for the loans.
d) Loans are unsecured
Collateral is not required for the borrowers to get loans through peer-to-peer lending.
e) No prepayment penalty
The borrowers are not subject to significant penalty if they decide to pay off the loan before its due date.
Borrowers – Cons:
a) Loan amounts may not be available
Large amounts are usually not available as typically groups of retail lenders supply the amounts.
b) High interest rates
Borrowers with low credit scores that unable to get loans from the banks are normally charged with high interest rates.
c) Privacy exposure
Most of the peer-to-peer lending platforms require public disclosure of the borrowers’ financial history and information before lenders choose to bid the loans.
Lenders – Pros:
a) Low investment capital
The initial investment capital for the lenders to participate is very low.
b) Higher return on investment
Lenders enjoy much higher returns with more than 10% yield p.a. as compared to placing deposits with the banks.
c) Diversification of risk
Lenders can diversify their loan portfolios to lower the risk of investment based on their risk appetite.
d) Alternative investment
Peer-to-peer lending appears to be a good investment alternative for the investors to earn a steady stream of passive income. Besides, investors do not need specialized industry knowledge.
e) Discretion over investment
The lenders have full control over their loan portfolios with the flexibility of reinvesting or withdrawing their returned capital anytime.
Lenders – Cons:
a) Risk of default
The lenders are exposed to risk of default by the borrowers and the loans are generally uninsured, thus losing their capital in the event of default.
b) Lack of regulations
There is lack of regulations and framework to govern the peer-to-peer lending activities in some territories as the industry is still at infancy stage.
c) Risk of insolvency
There is a risk of peer-to-peer lending operators going out of business causing the lenders to lose their capital. In contrast with the banks under financial distress, bailouts are undertaken by the central bank or government to protect the interest of the depositors.
Overview of Peer-to-Peer Lending in Malaysia
Peer-to-peer lending has emerged in Malaysia since 2016 when Securities Commission Malaysia (SC) introduced a regulatory framework to govern the registration and obligations of a peer-to-peer lending operator. Malaysia became the first country in ASEAN to regulate peer-to-peer lending. The primary objective is to provide an alternative to the Small and Medium-Sized Enterprises (SME) to obtain financing to spur economic growth. Further, it also provides an alternate investment offering to the retail investors thereby promotes liquidity in the financial market. Nonetheless, SC prohibits peer-to-peer lending operators to offer personal loans through its platform.
Obligations of Peer-to-Peer Lending Operators in Malaysia
Based on SC requirements, a peer-to-peer lending operator must be incorporated under Companies Act 1965 with a minimum paid-up capital of RM5 million. Among other criteria, the directors of an operator must demonstrate that they are fit and proper to operate such business. In addition, the operator must ensure that a transparent and effective risk scoring system is in place. The obligations of an operator include determining the suitability of the issuers and ensure compliance of its platform rules. This involves background checks, credit assessment, disclose relevant information to investors etc. The operator also must place the amounts deposited by both investors and issuers in a 3rd party trustee account before making any disbursement.
Issuers of Peer-to-Peer Lending in Malaysia
SC does not impose a limit on the financing amount that an issuer can raise through a peer-to- peer lending platform. An issuer only allows to retain the sum raised if the amount exceeds 80% threshold of the target amount. Nevertheless, an issuer can raise funds concurrently at different peer-to-peer lending platforms.
Investors of Peer-to-Peer Lending in Malaysia
SC encourages retail investors to limit their investment to a maximum of RM50,000 at any one time to reduce their risk exposure. The operator must disclose all fees, charges and expenses to the investors in connection with the investment. Besides, investors can also obtain relevant information relating to the investment such as purpose of funding, business plan, issuers’ background, historical financial information, etc.
There are currently six licensed peer-to-peer lending operators in Malaysia as shown below.
Many people are still unfamiliar with peer-to-peer lending in Malaysia as it’s still at infancy stage. Nonetheless, peer-to-peer lending market is gaining traction in recent times due to ease of obtaining funds in contrast with the stringent procedures that the financial institutions typically practice. The number of investors is growing rapidly as well due to its lucrative returns with up to 18% interest rate p.a. and low entry requirement with a minimum amount as low as RM100. For those who want to give it a shot, you may refer to A Complete Review of P2P Lending Platforms in Malaysia. It provides a complete review and comparison of each peer-to-peer lending platform in Malaysia. You can choose the platform that suits you the best in no time!
The Bottom Line
In summary, it’s undoubtedly that peer-to-peer lending evolves as a game changer in transforming the landscape of the financial services industry. Many may argue that the emergence of peer-to-peer lending is still at the infancy stage and has yet to experience a full credit cycle of the financial ecosystem. Therefore, it may to be too early to suggest that peer-to-peer lending will be the way forward to replace the conventional banking system in years to come.