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. However, many investors fail to observe the underlying risks of investing in P2P lending before getting their toes wet. 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 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.
However, 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 with 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 partly 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 exposure on 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. Unsurprisingly it has now become the talk of the town. 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. The most well-known being Ezubao, once China’s biggest P2P lending platform uncovered being a $9 billion ponzi scam involving more than 900,000 investors.
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 are 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. Worry not, 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. You may refer here for the complete SC framework for P2P lending in Malaysia including the obligations of a P2P lending operator.
4. Liquidity and Prepayment Risks
There are other risks that are less pervasive nonetheless may still be relevant to take into consideration before you invest in P2P lending. Investing in P2P lending creates a liquidity risk to 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 is 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. However, it’s important to understand the risks lurking beneath the surface of P2P lending investment before you invest. You may end up leaving yourself in despair if you invest in P2P lending hastily without proper understanding. Nonetheless, many investors tend to overreact to the risks of investing in P2P lending and magnify the problems unnecessarily due to their ignorance.
“In investing, what is comfortable is rarely profitable.” – Robert Arnott
As a piece of advice, investors should have a thorough understanding on the nature of the risks and perform due diligence on the P2P lending platforms before they invest. Refer here: A Complete Review of P2P Lending Platforms in Malaysia for better understanding and comparison of P2P lending platforms in Malaysia. More importantly, investors must diversify their investments to minimize the risk of their investment portfolios. Refer Best Way to Avoid Risk of Investing in P2P Lending Malaysia. GOOD LUCK if you are now ready to invest in P2P Lending!
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