Peer 2 Peer Lending (P2P)

By September 25, 2017 Blog

Investor’s Query: Nowadays I have heard a lot about Peer 2 Peer (P2P) Lending concept. Is it worth looking at it to lend my funds through it to higher rate of interest? Let me have your suggestion on the same.

Mr. Gerard Colaco: I will very definitely not recommend the Peer 2 Peer (P2P) Lending product/platform to any investors for the following reasons.

First, it is not for nothing that consumer loans yield higher interest. They come with attached higher risk, including, very importantly, the risk of default.  Banks and other professional lenders cannot fully guard against these risks.  What chance does the common investor have?

Second, the investor is supposed to have the expertise, knowledge and wisdom to choose the borrower or buckets of borrowers.  When more than 90% of ordinary investors do not know the meaning of kindergarten-level financial terms like credit risk and price-earnings ratio, the company’s belief that they will be able to evaluate financial risk and choose between borrowers and ‘buckets’ is laughable.

The greedy lenders who brought about the global financial crisis despite (or because of?!) their Ivy league degrees and complex derivative products, could not or would not judge credit risk.

The prize jackasses in the credit rating agencies could not warn economies or investors in advance about the impending doom that was going to befall them.  I’m surprised that credit rating has not been banned outright.  I have hardly come across a more wasteful economic activity.

The world’s leading economists could not, in sufficient numbers, predict the crisis, pin down its causes and warn governments in advance.  What chance then, does a common investor have in taking prudent decisions about risky lending?!  The average investor is more likely to kick the bucket once he comes in contact with P2P platforms, its borrowers and buckets.

Third, one may ask, isn’t investment in P2P lending feasible if investors are ‘guided’ by investment advisers?  Where investment advisers are concerned, the less said about them, the better.  Their knowledge of credit risk and its evaluation is likely to be much worse than that of investors.  Their knowledge of which crappy product is likely to fetch them the highest revenues on the other hand, is generally of a Nobel Prize winning level.

You can be sure that the worst products for an investor will be offered to their clients, because (and this is even more certain) the worst financial products always generate the best revenues to issuers and distributors.  In normal investment itself, being ‘guided’ by an investment ‘adviser’ is akin to being at the receiving end of a guided missile.

For me, there is only one model to follow for grading myself as an investment adviser.  That is the one found in The Intelligent Investor.  This is what Benjamin Graham has to say:

“The truly professional investment advisers are quite modest in their promises and pretensions.  For the most part, they place their clients’ funds in standard interest and dividend-paying securities and they rely mainly on normal investment experience for their overall results.

“In the typical case, it is doubtful whether more than 10% of the total fund is ever invested in securities other than those of leading companies, plus government bonds (including state and municipal issues), nor do they make a serious effort to take advantage of swings in the general market.

“The leading investment-counsel firms make no claim to being brilliant.  They do pride themselves on being careful, conservative and competent.  Their primary aim is to conserve the principal value over the years and produce a conservatively acceptable rate of income.”

Fourth, where is the regulatory structure in these products and how is the investor protected?  What if one or more of the worthies in such P2P platforms turns out to be the long lost twin of Bernie Madoff?

Have we so easily forgotten the collective investment schemes masquerading as limited-membership real estate investment trusts that were popular a few years ago?  Thousands of investors lost money is these hair-brained schemes and others, desperate to get out, are trapped without any option to liquidate even their battered holdings.  They have mainly themselves to blame, having signed pages of one-sided terms and conditions without reading them.

Yesterday, I read that all peer-to-peer lending platforms will be regulated by the RBI, and treated as NBFCs.  Big deal.  As thousands of cases have shown, this will most certainly not prevent serious investor losses.  It is only that some regulation may be a trifle better than no regulation.  Co-operative banks are regulated by the RBI.  Tell that to the millions of fixed depositors in the tens of thousands of co-operative banks in India that have folded up over the last few decades.

Common investors will be looking at the “15%” return assurances of P2P sales hype, while they blindly press the “I Agree” button on the terms and conditions pages of P2P platforms.  Later on they will cry that they’ve been cheated. I have seen this tragedy playing out too many times in my 32 years in this business, that I am no longer a skeptic.  I am a cynic and a proud one at that.  It is my cynicism more than my knowledge of investment that has saved many of our clients.

Fifth, a lot of such supposed flashes of brilliance have from time to time surfaced and then promptly vanished, leaving a trail of investor wreckage in their wake.   I will remain with Dr William Bernstein.  He is clear that investment in debt must be only in very short-term and highly safe bonds.  Any investor who wants to take a risk to earn higher returns over the long term must choose equity and not rubbish like P2P lending.

I am certainly not against new ideas and new thinking in finance.  I also very definitely support the use of technology in financial innovation.  But the allocation of finance in these areas must be by extremely high net worth individuals with specialised knowledge, angel investors and venture capital funds, not by the common investor.

In short, investment in these areas must be by people with, not high risk appetite, but with ultra-high risk capacity, who, at the time of investment, are prepared to lose their entire financial commitment without complaint.

As I will continue asking without apology, when venture capital funds have such high failure rates, what chance does a common investor stand in these shark-infested financial waters?  And when Warren Buffett has now officially won his ‘million dollar’ 10-year bet against a bunch of hedge-fund clowns, clients of offices like yours and ours NEVER need P2P lending.

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