Elizabeth Kerr looks at a low stress P2P model where you have time to go and make yourself a cocktail

Elizabeth Kerr looks at a low stress P2P model where you have time to go and make yourself a cocktail

By Elizabeth Kerr

Peer-to-peer (P2P) lending is really gaining some momentum here in NZ, with second and third providers due to hit the scene soon. As you know, I am a big fan of the whole sharing economy. I love that people can cut out the middle man, create win-win outcomes with their money and trust the intentions of their fellow man.

So just humour me this week and imagine a P2P lending world where the investor never lost any money, or the borrower was never taken advantage of by being charged extortionate interest rates? Sounds good right?!

Welcome to another side of P2P lending

You see, there are two types of P2P lenders in this world of ours. The first are what I call the “pick and choose your own adventure” type (Harmoney falls into this category). P2P platforms under this category mean you (the investor) get to choose the loans you fund, therefore becoming a quasi credit expert reliant on the ability of the platform owners to weed out the wheat from the chaff of borrowers so to speak. If you don’t have any experience in credit risk analysis, then you’re left using your own judgey-pants for intuition.

Lots of investors love this approach. They feel empowered and they get into the nitty-gritty, developing spreadsheets with fancy algorithms and adopting all sorts of lending rules for the loans they will invest in to get the best outcome. They often log in to check if there are loans available which match their lending rules, and enjoy that frequent contact with the platform.

My Harmoney experiment has taught me that I am not this type of person. In this season of life I am more of the "set it and forget it" type of person, because quite frankly my other investments take up a lot of mental energy (right now one of them is mashing a sandwich into the back of my couch).

In this category there is no real fool proof way of knowing whether one loan will perform well or go into default; so as an investor we are told to diversify as much as possible and just take the risk on the chin by building it into our expected return.

But there is another way…

Enter in the second model of P2P lending originating from the UK. The most notable example of this type is RateSetter, originating in London. This P2P model says to me in a calming voice “Stop… go make yourself a cocktail... you don’t need to worry about picking and choosing loans – that’s what we're experts at... you just understand our P2P business platform, provide your funds and we'll use our skills and diversify on your behalf… just relax and watch your money machine grow…”. Well don’t mind if I do thank you very much. But let’s look at what makes this model so different… dare I say it, stress free:

1. A provision fund. RateSetter was the first to introduce the “Provision Fund”, making investors around the world sleep easier at night. In simple terms this is a bucket of money used to pay an investor, should a borrower default on their loan obligations at any time. The money for this fund comes from a little bit extra the borrowers repay on top of the base interest rate for their loan. This money is not refunded to the borrower - it remains in the provision fund. Given that most borrowers don’t default, there is a healthy assumption that there will always be money available to pay you back should one of your borrowers go awol.

2. You tell the platform what your borrowing rules are and it just does it all for you as the demand becomes available. For example, if I want to lend my money towards 1 and 3 year loans only, and at 7% return. Boom… the platform does it automatically until all of my money is invested/reinvested.

But there is an interesting third thing which I think will slowly weed out the first generation category of P2P lenders. (Bold statement, I know!) And that is supply and demand (or greed and contentment).

Under the first “pick and choose” category, a borrower is assigned an interest rate depending on their risk profile. It’s up to them to decide to accept it or go elsewhere. Under the second model the borrower, once qualified as a customer, can go onto the platform and choose a loan which meets their needs and risk. Need bridging finance for a car, then no problem; choose a month at the best interest rate available. Who sets that rate? The lender does.

Remember above I said the lender tells the platform what interest rates and terms they are prepared to lend to; well that tells the borrowers what loans are available. So if individual investors get greedy then presumably borrowers won’t choose to accept their loans over more reasonable interest rates. Theoretically this means the rates would naturally sit lower/closer to market rates or borrowers would take their demand elsewhere. This solves the argument that investors are extorting borrowers by charging them such high interest rates.

So is this right for you?

Well if you’re looking for something as easy as putting money into a bank account, and not looking at it again, then this UK type P2P lending model would be more your thing. But if you like hands on, choose your own adventure style investments, then Harmoney will keep you excited for the time being.

But there is no P2P lender like this in NZ yet?

Yes and no. Squirrel Money plans to open for business next month and will follow this approach by having a provision fund and interest rates that will be set by the supply from investors. If you’re an investor and want to diversify into a bigger market, then thanks to the Trans-Tasman Mutual Recognition Regime, investors can access RateSetter. It started operating in Australia in October last year and to date can boast that it has had NO defaults in that time. They can accept investors from NZ, but the only downside is you need to send your money to the platform in Australia. Now that there are P2P currency exchange platforms in place such as CurrencyFair.com, making it ‘cheap as chups’. See P2P is popping up everywhere now!

In closing

I don’t know if little ole NZ provides the borrower demand for some of these bigger P2P lenders to come and operate here, but with more local P2P lenders starting up shop, I think they would do well to adopt some of the strategies evolved from the UK P2P lending scene, particularly the provision fund to protect and incentivise new investors. What are your thoughts?

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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I like the idea of this, and am having a bit of a play with it. But do wonder if it is sustainable.

1. Once people perceive value, i.e. that there are good returns, the supply/demand balance will shift, lots of investors, few borrowers, driving rates down.

2. And when Squirrel (and/or others) come along and provide a cheaper product to the safer segments of the market it could mean that Harmoney is only left with the worst/riskiest borrowers.

Never-the-less, a line in the water catches more fish than one in the boat.

provisional/pooled funds differentiate from banks how? It's just more transparent about which loans "might" (because pooled) be linked to your investment.

The possible size of the market is the big problem for NZ P2P operators.
I was all keen about Harmoney and invested a bundle of money on the assumption that the promised secondary market would allow me an exit path should I need it
But this market has not appeared. I presume that this is due to the small size of the market. I say this from watching Harmoney market place several times daily and observing the small amount of loans to be funded and the large amount of institutional funds that sweep the non fully funded loans so that non reach their cut-off date to be fully funded. If their are not enough investors to fill these new loans who is going to buy a bundle of loans off me?