In the good old days, people used stokvels as a form of social lending that allowed them to save and borrow money within their local community. While stokvels still exist, this concept has been taken a step further and formalised with the advent of peer to peer (P2P) lending.
What is P2P lending?
Simply put, social lending – or peer to peer lending – brings together creditworthy borrowers and smart lenders for the benefit of both parties. Sean Emery, CEO of South African P2P loan facilitator RainFin, says P2P lending networks that facilitate transactions between ordinary people with money to lend and those that want to borrow.
- It opens access to finance for consumers who were unable to borrow in the past
- It lowers the costs of credit for people who have good credit ratings.
- It introduces healthy competition to formal banks and microlenders.
Who qualifies for P2P loans?
For highly creditworthy borrowers, the benefit of P2P lending is that they should be able to access unsecured loans at rates lower than the prime plus two or three percent they can get from the banks. This pool of borrowers represents a low investment risk to the lender, says Emery.
“With the availability of credit bureau information, lenders are making their investment decisions based on the same information as the banks,” he adds. “The default rate for this class of customer will be around one in 15 times or the same as the banks experience. In essence, the business model is based on the same maths as the banks use.”
How is the risk distributed?
P2P lenders operate by offering lenders a pool of customers to choose from so that they can spread their risk. Since it is unlikely that defaults will occur in month one of the loan, they should get at least a portion of their principle back even from defaulting clients.
Loans for lower income brackets
P2P also has potential to help people in lower income brackets who are less creditworthy to access unsecured loans at lower rates than the predatory rates offered by many microlenders. Listed microlenders are looking for returns on capital in excess of 30%, which translates into exorbitant interest rates for the borrower, says Emery.
Friends and family loans too
The sector where RainFin expects P2P lending to make the most impact is in the facilitation of friends and family loans where its robust administration, legal and collection services provide lenders with the comfort to lend to people in their social networks. Such loans are normally well below market rates, yet give the lender a comfortable rate of return, says Emery.