What Are the Risks of Investing in P2P Lending?
The market size of P2P lending in Malaysia has grown rapidly since its debut in 2016. In recent times, P2P lending has become the new investing trend in Malaysia. Many people have rushed to invest in P2P lending due to its irresistible returns with low entry requirement. But many investors fail to observe the underlying risks of investing in P2P lending. Surprisingly, many investors pour their money into P2P lending not knowing what it means but merely following the herd. It’s important to understand the risks of investing in P2P lending before making your first move. Now, let’s go through the key risks that you need to be aware of before investing in P2P lending.
1. Risk of Default by Borrowers
The most apparent risk of investing in P2P lending is none other than the risk of default by the borrowers. Default occurs when the borrowers fail to make scheduled repayments on time to the lenders (investors).
P2P lending operators generally claim that several measures are put in place to minimize the risk of default. Other than having a rigorous and transparent credit assessment process as required by SC, such measures include obtaining personal guarantees from the Directors of the borrowers.
Besides, P2P lending operators may also outsource the collection efforts to debt collection agencies. In the last resort, they would initiate legal proceedings to recover losses.
But there’s still a possibility of investors losing their capital invested in a particular investment note if the borrower defaults. The reality is that the risk of default will never be eliminated.
To put this into perspective, traditional banks with years in operations have not ever maintained a zero default rate despite having stringent controls over their credit risk assessment processes.
2. Loans Are Not Secured/Collateralized
P2P lending platforms offer loans that are not secured or collateralized. In contrast to traditional banks, some borrowers pledge their assets as collateral to obtain financing. In the event of default, the banks will take possession of the assets to recover part or all of the bad debts. Collateral helps to mitigate the risk of default thus provides a layer of protection to the lenders.
Therefore, the risk of P2P lending loans is much higher. P2P lending operators do not guarantee any form of return to the investors. In other words, you as the lender or investor could end up walking away empty-handed in a worst-case scenario.
3. Business Risk of P2P Lending Operators
The number of P2P lending platforms that have gone bust and collapsed in China is on the rise. The turmoil sparks fear among the investors and many have rushed to pull their money out from the platforms.
Many P2P lending platforms have come under scrutiny in China as regulators have stepped up measures to crack down on illicit use of funds and Ponzi schemes involved in P2P lending. The increasing number of fraud cases in P2P lending has indeed shaken the investors’ confidence.
How About P2P Lending Operators in Malaysia?
You may now wonder what if the P2P lending platform that you have invested go out of business one day when you wake up in the morning. “Will all my money go down the drain?”.
Fortunately, such risk is less prevalent in the context of Malaysia P2P lending market. To put things into perspective, China has at least 50 million registered investors and close to $200 billion of outstanding loans. Thousands of P2P lending operators in China are largely unregulated.
As compared to Malaysia P2P lending market, there’re only six licensed operators with RM118 million raised as at June 2018.
The good news is that P2P lending operators in Malaysia are subject to relevant guidelines and SC regulatory framework. At the time of writing, SC had only issued six licenses to P2P lending operators in Malaysia.
You may have doubt or fear that similar instance may happen to your investment in P2P lending. Don’t worry too much. Under the SC requirements, a P2P operator must place all the monies received in a third party trust account (e.g. banks as trustees) before making any disbursement. As opposed to putting into the operators’ own bank accounts.
Besides, a P2P lending operator cannot cease its business without prior engagement with the SC.
4. Liquidity and Prepayment Risks
There are other risks that are less pervasive. But those may still be relevant to take into consideration before you invest in P2P lending.
Investing in P2P lending creates a liquidity risk for the investors. You cannot withdraw your money any time at your convenience once you commit into a particular investment note. You will only receive the principal and interest based on the maturity of each repayment. Savvy investors with a proper investment plan may not bother as they would typically set aside funds for emergency purposes.
Investing in P2P lending is also exposed to prepayment risk. Prepayment risk refers to a situation when the borrowers repay the outstanding loans before they fall due. Such instance may not be common. But it’s still a possible scenario given that all P2P lending platforms in Malaysia do not impose a penalty if borrowers choose to repay the loans earlier.
The drawback for the investors is the loss of interest associated with the future repayments. However, it should be less of a concern as it’s effortless for the investors to re-invest in other investment notes with similar interest rates.
No doubt P2P lending appears to be a great investment choice that provides attractive returns. But it’s important to understand the risks lurking beneath the surface of P2P lending investment before you invest.
As a piece of advice, you should have a thorough understanding on the nature of the risks and perform due diligence on the P2P lending platforms before you invest. You should also learn how to diversify to minimize the risk while maximizing your returns. Refer Best Way to Avoid Risk of Investing in P2P Lending Malaysia. You’ll learn the strategy to maximize returns at the lowest risk.
“In investing, what is comfortable is rarely profitable.” – Robert Arnott
For those who are interested to get started with P2P lending investment, you can refer to this article for the comparison of all P2P lending platforms in Malaysia. Refer here: A Complete Review of P2P Lending Platforms in Malaysia.
Personally, I’ve been investing in P2P lending via Funding Societies for months. And it’s really awesome! Refer to this article for a step-by-step guide to invest in Funding Societies. (Read Funding Societies Malaysia Review – Best P2P Lending Platform in Malaysia.) It also includes FREE tips on things to consider when you’re selecting a P2P lending investment note before invest.
GOOD LUCK my friend!