Transparency is something that the financial service sector has long been lacking. In fact, peer-to-peer lending rose to prominence on the back of a loud public call for more transparency and less corporate greed. Traditional P2P marketplace lending has transparency at its core.
Recently, however, many P2P platforms in the UK have started moving away from this model, to a model more akin to a managed fund, arguably a move away from transparency.
Why has this shift away from transparency occurred? Is the change being driven by consumer demand for change, or by the platforms themselves, as part of their own business growth strategies?
Transparency in financial services creates accountability, builds trust and encourages stakeholder engagement. In P2P lending, this manifests itself in lenders actively making lending decisions, engaging with borrowers and closely monitoring platforms on their debt recovery performance and operational processes.
Lenders compare platforms not only on their net return, but also on their customer support engagement and loan book performance. Retail consumers have very rarely been so engaged with a financial service provider. Everyone complains about their banking provider, yet few do anything to switch; the same is not true with P2P platforms.
The democratisation of finance and investment that P2P lending has created gives lenders the opportunity to choose who they lend to, how much, and at what rate. P2P lenders can expect to achieve returns between 5-20%; significantly higher than many other investment options.
Picking and choosing the home for their own money allows lenders to see exactly where their funds are going and what they will be used for. They can therefore price their own risk, and are expected to weather some losses when borrowers are unable to repay.
Lenders who engage in a P2P platform for long enough will undoubtedly experience some bad debt; and it is in this instance that transparency comes to the forefront. Despite risk warnings on all P2P platforms, a default on a lender’s portfolio will come as a shock and will often incite feelings of anxiety and anger, first directed at the defaulting borrower and then at the platform.
Many of the UK’s biggest P2P platforms have now stopped allowing lenders to make their own investment decisions; instead, lenders choose an account type that promises to yield an approximate return, and capital is auto-distributed across a broad portfolio of varying risk, to recipients unknown to the lender.
This prevents lenders making risk-adjusted lending decisions and eliminates lender engagement from the process. They must rely solely on the credit risk decisioning and integrity of the platform, removing many a layer of transparency.
Despite this, these platforms remain successful and popular amongst lenders. They have skulked back to a structure not greatly dissimilar to that of the balance sheet lenders that were so intensely criticised in 2007-8, but many consumers seem content with the new structure: why?
One must consider whether most consumers don’t in fact want transparency, but simply an easy way to make a return.
Consider scenario one: a lender invests on a platform where they choose their loans. At some point, one of their many loans defaults. They know exactly which business has failed, and will expect the platform to recover the funds by almost any means possible.
The human brain is wired to remember negative news over positive news, thus the news of default is remembered over and above any positive news, and over the fact that their net return is still positive and significantly above other savings or investment options.
To the average investor, this (often fleeting) bad news creates a lingering bad taste, one that is remembered and that colours their P2P experience.
Scenario two: the same lender opens a P2P account, selects their target net return, adds funds and logs out, content with the expectation that their account will achieve their target, only to return when they wish to withdraw their funds. Simple, but not transparent.
Which experience are most lenders going to prefer?
In scenario two, the lender’s portfolio will also undoubtedly suffer defaults, sometimes even to a higher degree. However, provided the platform has gauged the strength and performance of the portfolio correctly, the lender in scenario two will never know about these. They will also be unaware of the margin taken by the managing platform.
The lenders’ net returns arguably come down to the simple equation of the effort invested being directly proportionate to the resulting reward. Lenders who take the time to pick and choose their loans and manage the diversification of their portfolio may overall see a higher net return than those who have chosen to defer their judgement to the platform, allowing the platform to keep excess income from any return above the lender’s target return.
Both methods of investment have their merits and clearly suit different types of lender, but there is no doubt that this divide in lenders is reducing the transparency of the P2P industry.
If more lenders want a return for minimal effort and don’t truly care about transparency, will those more traditional marketplace platforms survive? We think they will. Despite there being many investors who are simply chasing a stable, carefree return, there are as many investors who take the time to carefully pick and choose, chasing a higher return, but deciding to trust their own judgement rather than put their faith in an automatic system.
For the platforms, transparency is a double-edged sword. Platforms that hold transparency in high esteem are often open to higher levels of criticism, as every move is available for scrutiny. For others, it seems that the guise of transparency has been used as a get-to-market strategy; one that is now being gradually withdrawn as the platforms pursue their long-term corporate objectives. Where mistakes have happened on these platforms, lenders have often only been notified long after they first came to light, and only when uncovered by third parties.
As long as all is well with the markets and economy, both sets of lenders will likely remain satisfied; the true test comes about when there is a downturn in the economy. Then we’ll see whether the crowd’s own individual investments will stand them in better stead than those who choose to defer their judgement to a higher power. This will not only test the varying investment and credit risk decisioning models, but also the regulators’ approach to regulating a market with such strong divides from its original intentions.
rebuildingsociety.com is a peer-to-business lending platform with a difference. Lenders on rebuildingsociety.com are encouraged to engage with the business borrowers, and choose the rate at which they want to lend.
Lenders are encouraged to engage with the businesses beyond the financial transaction, and where possible add additional value to the business. Visit rebuildingsociety.com to find out more.
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