Make money better: time to look at P2P lending regulations
by Ryan Ong
THE finance industry is all about innovation – no other industry has as many innovative ways to charge you for imaginary conveniences. On rare occasions, however, something good comes out of it. Like the ATM, employment opportunity for economists, and peer-to-peer (P2P) lending. In the case of the last one, it’s still a bit iffy – P2P lending may be exactly what we need in the coming years – or a disaster zone. And it’s about time we start thinking about further regulations before someone decides to ‘innovate’ a little too much.
What is P2P lending?
In general, peer-to-peer (P2P) lending means borrowing money off people on the Internet, as opposed to borrowing money from a bank. The P2P company acts as the intermediary between borrowers and lenders.
If you have some spare cash, you can indirectly invest it by leaving your money with a P2P company. The money is loaned out to borrowers, who pay you back with interest. You also have the choice of who you want the money to be loaned to. P2P sites will vet borrowers, and put the borrowers’ portfolios on the site.
Funding Societies, CapitalMatch, and MoolahSense are the best-known P2P sites in Singapore. In April last year, The Business Times reported that CapitalMatch had around 100 investors while MoolahSense had around 1,000. The report also revealed some of the interest rates charged to borrowers, which range from 10 per cent per annum to around 24 per cent (on par with your credit card). Later in August 2015, The Straits Times reported that CapitalMatch had raised $1 million in funding.
P2P may be set for some good years ahead
While P2P is fairly new in Singapore, it is taking off at a good pace. And with the current economic outlook, P2P loans may become more attractive in the coming years.
More conventional forms of investment, like the stock market, have been volatile of late. This is on the back of various factors such as rising interest rates, unsustainable low oil prices, and growing instability in the Middle East. While some investors will flee to traditional havens like gold, P2P lending is sure to pique the curiosity of others.
The CapitalMatch website points out returns as high as one to two per cent per month (subject to variables), and the minimum investment amount is low at $1,000. This is a small enough amount that investors may be willing to take a risk; And at such a high return, many will decide the potential payoff is well worth it.
Also, the current obstacle facing P2P lending is trust. It is new, and investors are uncertain. But if we observe the progress of P2P sites abroad, such as Zopa (the UK’s largest P2P lending service), the growth and acceptance of these sites is exponential once a certain level of acceptance is reached.
As more people put money into P2P lending, and more loans are processed and paid back, its reputation will improve. The lack of trust will not remain an obstacle for long if P2P businesses continue in a reliable way.
Which is why it may be time for some regulatory firepower
First, let’s dismiss the idea that P2P lending is any kind of threat to the banking industry. This is not why it needs regulation. P2P lending is a threat to banks like Swiss army knives are a threat to weapons manufacturers.
P2P loans in Singapore are not necessarily cheaper than bank loans. At present, many companies that go to P2P sites for loans are not there because of competitive rates – they just lack the two to three-year track record demanded by banks for business loans. The interest rates on P2P loans need to fall significantly below that of banks before they become the preferred choice.
Even if P2P interest rates fall (which is as probable as the volume of investors and borrowers go up, and as competition stiffens), P2P companies will still not replace banks. Lending to small companies is not the backbone of the banking industry – banks have many high-value activities that P2P sites will not replace (wealth management, letters of credit, etc.)
It’s more accurate to say that, even if it takes off, P2P lending will replace one specific function of banks (small business loans), which hardly makes it a threat to the banking industry.
Rather, P2P sites need to be regulated because of the potential hazards to retail investors and to individuals.
Some of the key steps we should consider, before these companies grow any bigger, are:
- Ensuring the loans remain targeted at companies, not individuals.
- Regulating who can put money into P2P lending companies.
- Ensuring the scope of P2P services does not expand too far.
1. Ensuring the loans remain targeted at companies, not individuals
P2P lending abroad already caters to individual borrowers – it is quite possible, in other countries, to go to a P2P lending site and pick up a loan to buy a new MacBook. In Singapore however, P2P lending sites seem to have confined themselves to business loans. And we really want to keep it that way.
Online lending caused significant chaos in China in 2015. Because of loan restrictions from traditional banks, several retail investors (read: mom and pop investors) turned to P2P lending sites as a form of leveraging. They borrowed money to invest in the stock market, and when said market collapsed, it suddenly meant large numbers of them were unable to repay their debts.
That hits both sides – the lenders and the borrowers.
Also, when P2P lenders start catering to individuals, what we have is basically just another moneylender. They might also be more reckless than the usual moneylenders because they are not dealing with their own money. They’re lending out someone else’s money, and making a cut-off the transaction. They are much more incentivized to take risks, and give out loans.
While I couldn’t be happier at the thought of something else driving licensed moneylenders out of business, P2P lending sites are not an ideal replacement for them.
2. Regulating who can put money into P2P lending companies
If you go up to the average person, and show them the effect of 24 per cent returns per annum, their eyes will bug right out of their head. If you lend $5,000 at 24 per cent per annum, on a five-year loan, your eventual payout will be around $14,600.
Retail investors don’t have a wide range of investment options like that (at least not without a good defence lawyer.) So put it together in your head: high risk, high potential payoff, low initial investment. You know what that results in?
A more socially acceptable form of 4D for some people.
I’m not accusing P2P lending sites of running a lottery – I’m sure that’s not their intent. I’m just pointing out that some lay people will almost certainly see it that way. The urge to tikam and see which company will give you a payoff is similar to how some people gamble with stocks.
At the very least, we should have some kind of test from regulatory authorities to ensure everyone knows what they’re getting into.
3. Ensure the scope of P2P services does not expand too far
In December 2015, after China had wised up to the problems of uncontrolled P2P lending, they passed laws preventing the sites from going into wealth management, among other restrictions.
It’s an easy step for a P2P lending site: they already spend time and effort getting people to lend money. They may as well position themselves as wealth managers, who can build your retirement fund with their product. Likewise, it’s not hard to imagine P2P lenders building associated businesses.
For example, imagine another dubious gold trading scheme, where after you buy the gold you can also put it down as collateral for a P2P loan.
As P2P lenders expand, they are likely to seek sources of revenue that go beyond simply being a middleman. We should lay the ground rules early, to stop them morphing into some kind of vague sub-category of financial services.
Ultimately, P2P lending can bring more good than harm.
In 2013, small and medium-sized enterprises (SMEs) employed around 70 per cent of our workforce. It’s good that these companies have more opportunities to expand, and have alternatives beyond bank loans. But the key will be ensuring that P2P lenders keep to supporting our SMEs, rather than just becoming the internet version of a payday loan.
Featured image by Natassaya Siregar.
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