Online services that match lenders with borrowers are making rapid inroads into the Australian financial markets. These companies, which are commonly known as peer-to-peer lenders or marketplace lenders, use their websites and proprietary algorithms to connect investors with individuals or small businesses that require funds.
The heart of the business model of these peer-to-peer or P2P lenders is built on bypassing the banks, a strategy that allows high net worth individuals or other investors to make loans directly to borrowers. Consequently, through this process of disintermediation, individuals can get loans at rates less than those offered by banks and lenders can earn a higher rate of interest.
Although the P2P industry is at a nascent stage, it has tremendous growth potential. According to a 2015 Morgan Stanley report titled, Global marketplace lending: Disruptive innovation in financials, the value of loans made through P2P platforms will balloon to $22 billion by 2020. The report says that consumer lending has the potential to touch $10.4 billion while loans to small businesses could grow to $11.4 billion.
But the markets for loans to consumers and small businesses work in quite different ways. P2P lenders have structured their products differently for these two sets of borrowers.
Individuals can use marketplace lending platforms to take loans for debt consolidation, buying a new car or for some other purpose like carrying out home-repair work. Apart from low rates of interest, these platforms offer extremely fast online approvals.
In fact, loan applicants can get an immediate automated response regarding the rate of interest that they are eligible for, based on the data that they enter onto the website. The online application process is simple and quick and usually elicits a response within a day. If the applicant decides to accept the loan offer, funds are normally transferred within three days.
This is in sharp contrast with the traditional processes utilised by banks. Although most banks are now offering the facility of online applications, their procedures are a combination of what they have been doing over the years andtheir efforts to modernise. Despite the steps taken by banks, they are not as efficient as their P2P competitors.
How much financing can an individual borrower get and what are the rates on offer?
One of the prominent P2P lenders in the Australian market, SocietyOne, offers loans that can range from $5,000 to $35,000 for terms of two to five years. The rate of interest varies from 7.75% per year for borrowers who it judges have the best rating to a high of over 25% for what SocietyOne categorises as Grade D borrowers.
Loans to small businesses
Marketplace lending in Australia got its start with consumer loansbut financing to small businesses through these platforms is now picking up.
Small and medium sized companies that need funds for working capital or fixed assets can approach a P2P lender. They are subjected to a credit review process and if they meet certain basic requirements their details are shared with investors.
The P2P platform can give borrowers the option of getting a rate of interest that is based on investors’ perception of the risk that they are taking. Consider the procedure used by ThinCats Australia, to determine the rate at which funds are made available to small businesses.
A borrowing company can opt to auction its loan to investors who make offers for a portion of the required amount at their desired rate of interest. The P2P website automatically selects the lowest interest bids for the total loan amount.
ThinCats arranges loans of amounts between $50,000 and $2 million for periods ranging from 6 months to 5 years.
A word of caution
Before putting money into P2P lending investors should remember that:
- Investments made through marketplace lending platforms are not the same as making a deposit in a bank. The Australian government’s guarantee to certain savings products such as term deposits with banks does not apply to these investments. At the time of the next economic downturn, many investors could stand to lose money invested through P2P platforms.
- The Australian Securities and Investments Commission does not monitor the activities of P2P lenders. There are no specific regulations governing these companies. Investors would need to do their homework and understand the risks that they are taking before putting up their money.
- The risks in small business lending could be greater than in personal loans. Lenders to this segment are especially vulnerable to a downturn in the credit cycle.
- The higher rates available through P2P platforms for lending to certain sections of both the small business and individual loan markets is an indication of the risk involved. Losing money through marketplace lending platforms is a real possibility.
- Most P2P lenders have not been active long enough in the Australian market to build up a history of loan default rates.
Prospects for P2P lenders
Marketplace lenders make funds available to borrowers at rates lower than those offered by banks. They also give investors a higher rate of return than they can get elsewhere. In addition to this, marketplace lenders provide another benefit that will ensure their success. Investors get the ability to spread out their risk between multiple borrowers.
SocietyOne says that, on an average, there are 40 investors for each of the loans made through their website. This gives investors the opportunity to place money across a cross-section of loans that match their risk appetite. Even if one or two of the borrowers default, the return from the remaining would make up for the loss.
Because of the various advantages that P2P lenders bring with them, it is quite safe to assume that they will rapidly gain traction in Australia. But whether this mode of financing can achieve volumes exceeding $20 billion by 2020 as predicted by Morgan Stanley is questionable.
As they increase the amount of business they do, marketplace lenders will definitely shake up the country’s banks, which are already adapting themselves to face this new threat. In any case, the growth of the P2P sector will prove to be of great benefit to both investors and borrowers.