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You Have To Stay Alert For This Risk
My colleague Neil wrote about how we need to defend ourselves from financial disasters in 2 Rules To Lend Easily And Be Safe From Recessions.
Today I want to look at another big item that we need to protect ourselves from: greedy P2P lending websites.
Most companies are driven by growth and in the world of investments – including lending money.
It's not all bad for lenders like you and me when these companies grow. Small companies ultimately can't compete without growing. They can't cover their costs and they have to close down. It is uncertain what will happen to us then, as Jane wrote in Do I Lose Money If A P2P Lending Website Goes Bust?
But, when the P2P lending companies finally run out of room to grow, it can lead to bubbles and busts.
Because they have a tough choice:
- They can either halt their growth and quite possibly suffer a temporary small decline, much to the anger of their owners.
- Or they can keep pushing for more growth by weakening their standards to accept ever more borrowers higher up the risk scale.
The greedy ones increase risks
History shows that companies often keep pushing for growth. It's not just pressure from the companies' owners, but their own greed and other people's: they all convince each other that everything has been going so well and therefore it will continue to go on that well if they just keep pushing their growth at the same insane speeds.
We can expect that at least some of the peer-to-peer lending companies will greedily choose to try to maintain their growth trajectories rather than their discipline. Any minor knock on the economy could see bad debts spiral out of control.
Disciplined borrower selection can increase risks too!
If we take other investments as our example – and we should – then the alternative is not entirely safe for lenders like you and me either.
If the P2P lending websites decide to be disciplined, they will continue to attract more lenders even though they can't accept a greater number of borrowers.
Unless they also cap the number of lenders then supply and demand will force interest rates down. If the rates get too low – and sometimes they will – then they will be too low for the risks involved.
So the risks for lenders rise despite – and even because of – the P2P lending websites' high standards!
The big picture today
So individual lenders like you and me need to keep track of the warning signs that discipline is getting looser.
Currently, there still seems to be a very long way that most peer-to-peer lending companies can grow before they hit a wall.
While P2P lending has virtually doubled every year since 2005, it is still just on target for a total of around £3 billion lending this year. This is a tiny fraction of the total annual bank lending market, which is measured in hundreds of billions.
In addition, the larger players have plenty of room overseas to expand. RateSetter is already in Australia, Funding Circle is in the USA, and the heads of RateSetter and Zopa were both in Asia this week to look into interesting opportunities for expansion there.
That's why 4thWay's risk warning indicators aren't flashing red. Not even orange.
4thWay's Alert Service tracks over a dozen risk and interest-rate warning indicators at the peer-to-peer lending websites. Sign up below.