April 26, 2019

What are the risks of investing in short term loans on P2P/P2B platforms

Risk/reward ratio is at the heart of each type of investment. A rule of thumb remains the same, the higher the risk, the greater the reward, the lower the risk, the lower the reward. Institutional investors seek the type of investment options that offer the highest return with the lowest risk. Risks may vary and some investments may have so many of them that it may be unwise to even consider them. A relatively new way to invest is P2P/P2B platforms. Despite criticized by the mainstream these alternative finance platforms have gained more and more popularity in recent years. Let us look and see how risky they are and how those risks can be reduced, and profit increased.

Not all alternative investment platforms are created equal

Even within the alternative lending/investment platforms, there are significant differences that may impact your risk/reward ratio. Some platforms offer personal loans to invest in, other real estate projects, others such as Debitum Network, focus on investing in short term loans for businesses (invoice financing and business loans).

Obviously, the percentage of defaults on the platforms vary greatly too. One of the leaders in the alternative lending/investment market Zopa has around 0.6% of defaulted loans, while another prominent player in the field (according to independent research) may have around 30%. In the 9 month period of existence, there has not been a single defaulted loan on Debitum Network platform. Commercial banks typically have around 1%-2% of defaulted loans.

Online platforms that offer users to invest in personal loans or payday loans may have high-interest rates: 15%-35%. However, taking into account that on some of the platforms 1 out of 5 investors may lose money, the average net return on them will go down to around 10%. It is obvious that the aspect of safety should be taken more seriously while talking about investments and returns on the platforms.

What are the risks and how can they be reduced?

A borrower may default on its’ obligations to pay off the loan and it is the biggest risk for an investor who has put money into such an asset. The invested money can be lost and never repaid.

To avoid such a scenario, a lot of (not all) platforms have implemented a buyback guarantee, which basically means that if the borrower is late with his repayments by more than 30-90 days (60-90 on Debitum Network platform. The actual number depends on the loan originator that issued a specific loan), the broker/loan originator will have to buy back the specific loan with the outstanding principal and interest. So, if a specific loan defaults, the investors’ risk is reduced to the minimum.

Another risk, that has much less likely probability of happening is when the loan originator goes default. This happens from time to time. When Eurocent loan originator (on Mintos platform) went broke, investors that invested in the assets of the loan originator, lost their money. Despite the fact, Mintos is doing everything in their power, there is little hope for investors to regain their invested balance and the interest earned on it. That’s why the buyback guarantee is as good as the loan originator that provides it. A proper selection and thorough screening of loan originators are necessary before onboarding them on an investment platform. Debitum Network selects loan originators carefully as well as their assets that are placed on our platform for investment. Due diligence parties as well as risk assessing companies do thorough risk rating defining the probability of default of the borrowing company and the loans uploaded on our platform.

Extra measures to ensure the safety of investors’ funds

Debitum Network solely focuses on loans for businesses as businesses have a higher chance of repaying the loan than private individuals. Businesses will unlikely borrow at such high-interest rates that some P2P lending platforms offer. Offering extra guarantees and taking extra risks borrowing at 20% is something that SMEs will hardly ever do. Private individuals that may take a loan for a car or a home will have to undertake very high risks that they are not very skilled at handling, thus increasing the likelihood of a potential default and consequently loss of the investors’’ money in the given loan.  

P2P platforms similarly use other protection methods for investors funds. Collateral from borrowers or real estate can serve as a guarantee that in case of default, it will be used to repay the investors. However, even sold the collateral may not be enough to compensate the entire invested amount, to say nothing of the outstanding interest. Real estate in the same fashion can be an illiquid asset and it may take a lot of time to sell it to repay the investors (with no assurance that they will get the full invested amount back or due interest). In that respect, a buyback guarantee is a far superior method for protecting investors’ funds and profits and the loan originator (in case of default of a specific loan) buys back both outstanding principal and interest.

Personal guarantees from the owners of the borrowing businesses are yet another protective measure to ensure the safety of investors funds. By the guarantee, the owner of the business guarantees, that if the business fails to pay off the loan, he/they will pay it off. It is typically not tied to a specific asset. In the event of non-payment, the lender can go after the personal assets of the guarantor.

Some platforms employ third parties to do risk assessment and due diligence services. This ensures transparency and quality of services as no conflict of interest is involved. Our own Debitum Network takes these service providers from countries where borrowing parties reside and thus, risk assessment or due diligence services are more accurate due to the specialization of the party doing the services and the knowledge of the local market.

Want to invest in low-risk assets in Debitum Network?

On Debitum Network we apply all available security measures to ensure investors funds’ are safe. Last week we onboarded a new loan originator Aforti Finance, who is the leading non-bank lender in the Polish market. This enables us to provide new investment opportunities, flexibility, and options to choose from for our customers. The first assets from the loan originator have already been uploaded on Debitum Network platform and you can start investing in them. They have attractive interest rates and a buyback guarantee. Check them out!


Disclaimer: Investments in financial products are subject to market risk and any investment should only be done with risk capital. The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.