My last article, Who’s afraid of mutual funds? did stir up curiosity about mutual funds and their decent yields compared to stock picking in the stock market. The apparent lack of investment knowledge, amongst Malaysians, is quite troubling especially when Malaysians are enduring higher inflation after fuel subsidies were scrapped.
Inflation is your biggest enemy. It seeks to undo all the wealth that you have accumulated. The only resolution against inflation is investing and I hope that this blog serves to disseminate investment knowledge which will be acted upon.
Today, I will be talking about P2P lending. Just so you know, this post is about my first-hand experience in P2P lending, as your worthy guinea pig.
What is P2P lending?
P2P lending or peer-to-peer lending means the coordination of a group of people (either individuals or legal entities) to pool in money (crowdfunding exercise) for the sole purpose of lending the said pooled money (or principal) to a borrower.
In exchange, the borrower (usually a business seeking short-term financing) promises to repay the principal, and on top of that, the interest, over a set period of time.
Your investment return is the interest on the principal.
Most, if not all, P2P lending operators run an online platform.
Is P2P legal in Malaysia?
In case you are wondering, yes, P2P lending has been legalised in Malaysia. These P2P lending operators have been given the go-ahead, in 2016, by the Securities Commission.
What are the potential returns?
The rates are as competitive as those offered by institutional lenders on the premise that the lending is unsecured.
Unsecured lending is where a lender lends without the need for a borrower to offer a collateral as security. Because there is no collateral, the interest rate is relatively higher than the interest rate offered by lenders for secured lending. Of course, other factors are also taken into account in determining the interest rate such as:
- the credit worthiness of the borrower;
- nature of the borrower’s business (a business in a high risk industry would be offered higher interest i.e. technology industry)
From my observations, the interest rate is within the ballpark of 10-14% per annum. It is relatively higher than most conventional debt investments such as bonds, debentures and fixed deposits (but junk bonds may offer surprisingly good returns).
What are the risks?
The main and obvious risk is the risk of default by the borrower.
Other risk may include the P2P lending operator going under which may be more of an inconvenience or nuisance rather than a risk of a loss to your investment. This is because the pooled funds are segregated and held entirely by a trustee appointed by the P2P lending operator.
What does a P2P lending operator do?
The P2P lending operator establishes a platform to accommodate both, lenders and borrowers. For example, a business, in need of a lending, may approach the P2P lending operator. On the other hand, a P2P lending operator actively promotes its platform to investors so that there are sufficient members to fund the lending.
When a potential borrower has fulfilled the credit requirements and is given the green light, the P2P lending operator will invite members, on its platform, to crowdfund the lending. Only after the crowdfunding has reached its intended target, the borrower is able to draw down on the lending.
For example, should a potential borrower requests for a lending amount of RM1 million, members would have to pool in their money to reach the said RM1 million mark. That must be done within a certain period of time which is predetermined by the operator. Only after the funding achieves the intended RM1 million mark would the fund be lent to the borrower.
If the fund fails to achieve the targeted RM1 million, within the predetermined period of time, the P2P lending operator may extend the crowdfunding time.
Investors also give an authority to the P2P lending operator to pursue debt recovery should a default arises.
What are the disclosures provided by P2P lending operator to members?
Like any regulated investment, the P2P lending operators are obliged to disclose the risk associated with the investment and also pertinent information about the borrower which includes:
- The terms of the lending (the amount of the lending, whether the borrower pays in monthly installments etc)
- The nature of the business of the borrower.
- The entity that owns the business (whether it is a company, partnership or sole proprietor)
- A background of the borrower (whether it is solvent, involved in litigation or blacklisted by any credit rating agencies)
- A summary of the directors of the borrower, if applicable.
- A past 3-year and current year financial report of the borrower (Profit and Loss and Balance Sheet).
- Bank account statement (monies in the bank account(s) of the borrower).
However, information which can identify the borrower’s identity remain undisclosed.
Be sure to understand the associated risks in this type of investment before pursuing any crowdfunding exercise.
Any tips to ensure maximum gain and minimum risks?
Do not put all of your eggs in one basket
There are usually a few crowdfunding exercises a month. Say, if you have RM5,000, split your investment into 5 portions and invests them in 5 different crowdfunding exercises. That way, if one defaults, you will not lose all of your investment as illustrated below:
1 crowdfunding exercise x RM5000 x 10% per annum = RM500
5 crowdfunding exercises x (RM1000 each x 10% per annum) = RM500 (but risk of losing all of your investment is spread out)
From the illustration above, you stand to gain the same amount of return but your risk is substantially mitigated.
Be selective. It’s your money, after all
Read through the borrower’s financials, especially for the borrower’s cash flow statement and its ability to service short-term debt. It the cash flow is too constraint, move on; don’t attempt to take the plunge and hope for the best. A casino is where you should be if you want to indulge the latter.
What are the fees involved?
Generally, the P2P lending operator will get a 2% cut from your profits. Hence if the interest rate is 10%, you will effectively get an 8% return.
Any tax implications?
As much as we all hate to pay tax, unfortunately, the returns from P2P lending is taxable as it is considered by the good people of the Inland Revenue Board as interest income.
What P2P lending operator on which you are basing this article?
I am subscribed to Funding Societies Malaysia. There may be other better ones out there.
I suggest that you subscribe to more than one P2P lending operators for regular crowdfunding exercises. However, please do your research as fundraising exercise may differ from one operator to another.
My final thoughts
P2P lending is one of the most innovative ways of fundraising. It benefits individual investors, seeking good investment returns, and also borrowers, seeking for competitive borrowing interest rates.
Like all investments, there is an inherent risk of a loss. However in this case, be prepared to lose all of your investment if a borrower goes bust. On top of that, the issue of taxation may arise.
Nonetheless, with effective risk management, i.e. do not put your eggs in one basket, and research, P2P lending may be viable over the long run especially for those who can’t stomach the volatility of the stock market.
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