Peer-to-peer (P2P) lending , known in Portuguese as “collective loan,” “collective financing,” “lending community,” or “peer lending,” is part of the biggest financial market revolution in recent years, with the emergence of FinTechs – startups that use technology to simplify banking services and replace banks. More information at labeurettenue.com
Recalling the Traditional Banking System
- The Peer-to-Peer Lending Proposal
- How it works?
- Who can participate?
- What are the advantages?
- But what about the risks?
- Peer-to-peer: History and Future Prospects
- The beginning
- World Platforms
- Latin America
- In Brazil
Recalling the Traditional Banking System
Well, before talking about peer-to-peer lending , it’s worth remembering basically how a bank works: On the one hand we have investors, who put their savings in the bank in exchange for a return – for example the famous savings. On the other hand we have borrowers, who take money from the bank and repay with the addition of an interest rate. Simply put, the bank’s business model is to provide the lowest possible return for investors and, on the other hand, the higher interest rate for borrowers, so the difference is the margin left for the bank. This profit margin is known worldwide as bank spread . The bank spread is the difference, in percentage points (pp), between the interest rate agreed on loans and financing (application rate) and the funding rate. Banking Spread = Interest rate – Rate of return For example, if an institution raised funds through CBD with a return of 12% pa to investors and granted a loan with a rate of 40% pa, then the bank spread of this operation is 11 pp: Bank Spread = 40% – 12% = 28% = 28 pp Through this spread the bank gets its billing, which after all costs and expenses (staff, maintenance, agencies, etc.) will generate its net profit. The table below shows a comparison of the banking spread in 2011 and 2015 in Brazil.
Source: Central Bank Report Note that the spread is much larger for individuals than for legal entities, and the targeted credit modality (loans associated with a specific purpose – property purchase for example) offers rates much lower than free credit, a mode in which the borrower You can do whatever you want with the money. This spread of approximately 30 pp for individuals places Brazil as the runner-up spread worldwide, as we see in the World Bank graph below:
Source: World Bank Banks say they need to have a high spread in order to pay off bad debt. However, analyzing the default rate worldwide, we can not see a correlation between the high spread and the Brazilian default rate:
Source: World Bank The above table shows that Brazil has an average default rate of 3.3%, with the country being “only” the 72nd most delinquent in the world. Countries like Italy, Ireland, Russia, Belgium, and even Austria have a higher default rate. What is the result of being the country with the 2nd largest spread in the world and simultaneously having a low default rate? This account can only lead to one place: profit for the bank. And what happens in a crisis scenario? The interactive chart below allows us to observe, among other points, the profit and default of 3 large Brazilian private banks in the first quarter of 2015 and 2016:
Source: Folha de São Paulo In a scenario of national crisis, borrowers can not pay the very high interest rates of banks, increasing the default percentage. How good would it be for the national economy if there were a way to transfer credit without going through the gigantic spread of Brazilian banks …
The Peer-to-Peer Lending Proposal
In this context, P2P lending emerged as an alternative for both sides not to rely on banks. Now, if João needs money and at the same time Carlos has money to invest, why not connect them directly and guarantee better rates than they would get in the banks? Thinking in a simple and collective way, P2P Lending platforms are sites that connect people (or companies) who are looking for loans with investors seeking above-average returns.
How it works?
There are numerous variations on the way platforms work all over the world, but in general, they follow the steps below:
- The borrower joins the platform, fills in a series of information and requests the loan.
- The platform analyzes the request and approves or rejects it.
- If approved, the request is published on the platform.
- Registered investors access the platform and see all requests listed, choosing which ones are attractive to them and then investing.
- If the request receives a sufficient number of investors to complete 100% of the amount requested, the loan is then finalized and the amount collected is transferred to the borrower.
- In the subsequent months, the borrower must make the payments according to the agreed interest rate and term.
Who can participate?
P2P lending has emerged as a solution for people, hence the term peer-to-peer. However, nowadays there are many platforms that also accept companies as borrowers and institutional investors. There are also specialized niches platforms, such as student financing or real estate. That is, it is an open alternative for different segments.
What are the advantages?
It’s no news at all that banks are not meeting the needs of their customers. With peer-to-peer lending , users get a number of advantages:
On the borrowers’ side , the main advantage is the interest rate, which is generally lower than that offered by banks. In addition, the process is 100% online, so much simpler and easier than asking for a loan at a bank.
Already for investors , the rate of return is also the main advantage. That is, instead of obtaining approximately 6.5% per year in savings, or around 13% in a CDB, through peer-to-peer lending could get returns around 15% to 25% per year. return, simplicity, ease and total control of investments are other benefits.
But what about the risks?
Yes, of course there are risks linked to peer-to-peer lending, as in any investment with higher profitability. And we must treat them very carefully. To get the expected return, the investor must understand what they are and invest consciously. Here are some tips and points of attention:
- Understand the rules of the game: The first step is learning how the platform you are investing works. Each marketplace has a set of different rules, which vary in relation to several factors, for example, who establishes the interest rate, whether it is a predetermined auction or interest rate, the term of receipt of payments, etc. It is essential that the investor study them before investing.
- Diversify! Once you understand how it works, it’s time to invest! Rule Number 1: Diversify! That’s the main concept that an investor needs to keep in mind, do not put all the eggs in just one basket. Collective financing can offer much higher rates of return than other investments. However, to avoid losses, the investor must diversify their investment. My advice is that no single investment should account for more than 5% of the entire portfolio. While the amount invested is increasing, this percentage should be even lower.
- Invest consciously: Before making any investment, analyze and study the company or person who will receive your money. It seems a difficult process, and it is, but only at the beginning. By becoming a frequent investor, you will know the shortcuts of how to properly and quickly analyze a company or person applying for credit. Many platforms still offer tools that diversify and invest their money automatically, respecting some previously established filters. After getting confidence in the platform, this tool is a great alternative.
- Default is part of the game. Yes, unfortunately that’s how it works. As critical as you and the platform are, there will always be a percentage of borrowers who will not repay the loan as agreed. Be aware of this and do not let it affect your return. Remember rule number 1? Diversify! The conscious investor knows that X% of your portfolio may default, and this does not affect your return because it was planned to take that percentage into account. Find out what the average default rate of the platform you’re investing on, diversify, and take that loss percentage into account in your planning.
Following these steps, investing in collective financing platforms are great alternatives. Peer-to-peer lending has been growing immensely, and its immense potential is slowly being discovered.
Peer-to-peer: History and Future Prospects
The peer-to-peer lending is booming expo and conquering the world, but it was not always that success. It all began in 2005 with Giles Andrews, founder of British Zopa (pictured). Soon afterwards, the US Prosper and Lending Club appeared in 2006. In most countries, they faced regulatory problems, as the activity of approaching the parts carried out by the platforms is often confused with financial intermediation. It took time for this new modality if it proved a credit alternative that brings benefits to society. An example of this was Prosper, the second largest US platform that needed to stop operations for almost 9 months in 2008; and Zopa herself had problems with her operations in Italy.
However, around 2011-2012 the game has turned. Peer-to-peer lending showed its value and local authorities needed to act to regulate this new activity. As happened in England, where in 2014 the government recognized the growing importance of collective financing and regularized this new type of loans ( FCA 2014 ). Lending Club, the largest player in the West, launched its initial public offering (IPO) in December 2014, where it raised more than US $ 8.9 billion.
All over the world this type of lending is gaining more and more space and growth has been exponential, as can be seen in the chart below, which represents the total of loans facilitated in England, one of the most stable and mature markets:
The figure below provides an overview of the leading p2p lending platforms around the world: Companies of Peer-to-peer Lending in the World
In Latin America, the P2P lending market is not yet developed as in England or the USA. At present, the top three companies offering peer-to-peer loans are: Afluenta (Argentina), Cumplo (Chile) and Prestadero (Mexico). However, we are at a key moment where diverse platforms are emerging and must be supported as they foster the growth of local communities.
So far in Brazil there are not many lending options that use peer-to-peer lending, mainly due to central bank restrictions, which determine that only financial institutions can provide loans with interest rates above 12% per year. The alternative found by some startups in the branch was to partner with a financial institution, seeking to legitimize its operations in front of the Central Bank. Options for peer-to-peer lending platforms in Brazil:
- Loans for individuals: Many platforms are working with loans online, but so far none of them is peer-to-peer, that is, gets the capital from large investors.
- Corporate Loans: A good option for collective loans for small and medium-sized enterprises is Nexoos , which offers interest rates of 20% to 35% for requesting companies and investors of the platform. For the company, it is important to analyze the CET (total effective cost), which is the effective loan rate after accounting for platform costs and IOF (financial transaction tax); for the investor the rate to be analyzed is the IRR (internal rate of return), which shows the net return on investment.