You will be able to explain what you take on when you lend through a peer-to-peer or crowdfunding platform.
Kumar, a made-up 36-year-old logistics manager in Punggol, sees an advertisement for a platform that lets ordinary investors lend to Singapore small businesses. The headline promises returns of around 8% a year, far more than his fixed deposit. The businesses are real, the loans have fixed terms, and he can spread S$5,000 across many of them. It sounds like being a bank without the building. That is roughly what it is, and being the bank includes the part banks spend most of their effort on: dealing with borrowers who do not pay.
Peer-to-peer lending, often called P2P lending or lending-based crowdfunding, matches people who want to lend with people or businesses who want to borrow. In Singapore, the borrowers on these platforms are mostly small and medium businesses looking for working capital, invoice financing or short-term loans.
The platform checks borrowers, sets the interest rate and terms, lists the loans, collects investors' money, pays it to the borrower, then collects repayments and passes them on. It earns fees, from the borrower, from investors, or both. Read the fee schedule carefully, because a fee taken from your repayments comes straight off your return.
Platforms that arrange business loans for investors in Singapore are regulated by MAS, generally under a capital markets services licence. Check the platform's exact legal entity in the MAS Financial Institutions Directory, in the same way as lesson 3.4, Run a licence and terms check on one exchange, and note which activities its licence covers. A licence means the platform is supervised. It does not mean MAS stands behind any loan.
The 8% in Kumar's advertisement is the interest borrowers agree to pay. What Kumar earns is that rate minus the loans that pay late, pay only part, or never pay at all.
Here is a worked example with made-up figures. Kumar lends S$5,000 as ten loans of S$500 each. Each loan is for one year at 8%, with interest and principal repaid at the end, which keeps the arithmetic simple. If all ten repay in full, each returns S$540 and he gets back S$5,400.
Now suppose one borrower defaults and nothing is recovered. Nine loans return S$540 each, a total of S$4,860. Kumar has lost S$140, or 2.8%, on a portfolio advertised at 8%. If the platform recovers 40% of the defaulted loan, he gets an extra S$200, a total of S$5,060, and his return is S$60, or 1.2%. With two defaults and no recovery, he gets back S$4,320, a loss of 13.6%.
One bad loan in ten turned an 8% return into a small loss. That is how thin the margin is. When you lend at a fixed rate, your best case is capped at the interest rate, and your worst case is losing the principal on every loan that fails.
Watch also how the rate is quoted. Many business loans are repaid in monthly instalments, so your money comes back gradually and earns interest on a shrinking balance. Lesson 3.2 of How money works, Why a flat rate loan costs nearly double what it looks like, showed how a flat rate can mislead a borrower, and the same arithmetic can mislead a lender. Check whether the platform quotes a flat rate or an effective one, and how it calculates the return it shows you.
Most platforms publish statistics on defaults and late payments. These are useful, but only once you know how they are defined. One platform may call a loan defaulted once it is 90 days overdue, while another waits longer or counts only loans it has formally written off, and a loan that is late but not yet labelled a default may be missing from the rate altogether.
Ask also what the figures cover. A default rate across all loans ever made includes years when the economy was strong. The rate for loans made recently, or in a bad year, may look very different. If the platform has only operated through good times, its history tells you little about a downturn.
A P2P loan is usually held until it is repaid, and many platforms have no way to sell one early. Where a resale market exists, a buyer may only take your loan at a discount. So money you lend for a year is gone for a year. Lesson 7.3, Liquidity: how fast you can sell and at what price, takes this further.
The platform itself is a risk too. If it closes, someone has to keep collecting repayments from borrowers and passing them to investors. Some platforms describe a backup arrangement for this. Others say little. Find out what the terms say would happen to your loans if the platform stopped operating, and who would collect.
For Kumar, the honest view is that 8% is the most he could earn if every borrower paid in full. He would be lending to small businesses, some of which will struggle, through a company that is itself a small business. Before deciding, he wants to see one platform's actual record and exactly how it defines a default.
Read one platform's published default and late-payment statistics and write down how they define a default.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).