Why we were wrong about peer-to-peer lending

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Reza Machdi-Ghazvini,CAIA
Last updated on 14 September 2021

P2P lending criticism - why we were wrong

P2P lending is a young asset class compared to stocks and bonds. The P2P platform Zopa from the UK was founded in 2005 and was the first platform where investors could invest in P2P loans. Over time, the asset class P2P lending became more and more popular in continental Europe as well, and especially young investors started to invest in P2P loans as an alternative to traditional savings products.

As former bankers, we were initially a bit skeptical about the new asset class. Our dismissive attitude followed the general criticism of P2P lending and is also due to our background in traditional banking.

In this article, we want to discuss the typical criticism of P2P lending and would like to show, based on the historical development, why our skepticism of P2P ledning was not justified.

Typical criticism of P2P lending

In the context of P2P lending, the same criticisms that discourage various investor groups from investing in the asset class still come up again and again today.

Criticism 1: Lack of creditworthiness of borrowers

P2P lending crediworthiness

"On P2P platforms, only people who are rejected by banks get a loan" is a typical claim when it comes to the creditworthiness of borrowers on P2P platforms.

The question is whether there is any truth to this claim. Because most of the time, no evidence or proof is provided in this context to turn the claim into an argument.

If you have already invested in P2P loans, you will have noticed that some P2P platforms are very transparent about what the loan is used for. Sometimes it's to balance an overpriced overdraft, to finance education or even to fulfil typical consumer needs.

As soon as you take a little time to look at the individual loans, you will quickly realize that completely normal people are borrowing money on P2P platforms.

The fact that on P2P platforms only people apply for a loan who are rejected by the bank, we can't confirm and is in our opinion wrong.

Criticism 2: Eastern European countries are considered developing countries

P2P lending emerging markets

Except for the German platform auxmoney, all major European P2P platforms are based in the Baltic States. This means that they are located in the Eastern European part of the European Union. Nevertheless, the same prejudices keep coming up in this context, which we deliberately do not list here because they are unfounded.

Most people are not even aware that Tallinn in Estonia is considered the European Sillicon Valley. A vibrant FinTech community has developed in the Baltics, so it's no surprise to us that the largest European platforms are all based there.

In Eastern Europe, it is much easier for P2P platforms to broker loans because there are not nearly as many banks as in Central Europe, for example. Also, banks in Eastern Europe are generally considered to be restrictive, which is why many people place their loan requests directly on the P2P platforms and no longer even ask a bank.

The prejudices against Eastern European countries are baseless and originate from a different time.

In direct comparison (GDP per capita), most Western European countries still have an advantage over the Baltic countries, but the lead is getting smaller and especially the Baltic countries could catch up with the Western European countries within the next 10 years.

Criticism 3: High returns are clear evidence of Ponzi schemes

P2P lending Ponzi scheme

At double-digit returns, many investors immediately become suspicious. But there are also experienced P2P investors who, for example, completely rule out auxmoney as a platform because the return of 5% p.a. is perceived as puny compared to other P2P platforms.

At the current time (February 2021), the platforms Mintos and Twino, for example, offer their investors average returns of 10% - 12% per year. Many loans on Mintos are short-term loans (payday loans) and Twino almost exclusively offers short-term loans.

Short-term loans typically have terms of 30 days. For such loans to be worthwhile at all, they must have double-digit returns.

Short-term loans can be compared well with overdraft facilities, which are still brokered by many banks with similarly high-interest rates. With short-term loans, financial companies earn their money through the masses. For short-term loans to be profitable, as many loans as possible have to be granted.

The high double-digit yields can also be explained by the different credit markets. Unlike other Western European countries, for example, there are far fewer banks in Eastern Europe. The competitive situation is therefore quite different, which is why interest rates are generally higher.

However, please do not be lured by unrealistic returns. If a platform aggressively advertises sustainable returns of over 20%, you must become suspicious.

Experiences with P2P ledning until the Corona crisis

P2P lending corona

It took a while for P2P lending to develop in Europe, as evidenced by the fact that some of the largest European platforms have only been on the market for 5 years. In the USA, a different development is emerging and P2P lending was able to establish itself quickly as an asset class through the platforms LendingClub and Prosper.

In Germany or example, auxmoney, which is at the current time (February 2021) the second largest European platform, entered the market in 2007 and has been able to maintain its position as the only real P2P platform on the market. 

However, it was not until the founding of the well-known Baltic platforms starting in 2015 that more momentum came back into the topic of P2P lending. The platforms were able to grow quickly; for example, Mintos has been able to broker more than €6 billion in loans. 

Because of their good usability, the new platforms quickly became the darlings of many investors. Bondora, for example, makes it very easy for investors to invest in a broadly diversified loan portfolio throught three different strategies.

But even in this context, many crash poets in particular kept pointing out that P2P lending cannot work and in the next big crisis, many platforms would collapse.

Stress test during the Corona crisis

The crisis hoped for by many critics then came in the spring of 2020 with the Corona crisis.

Grupeer crisis in March 2020

And indeed, the P2P platform Grupeer had to shut down its operations in March 2020, stating that the Corona crisis left them no choice. But, the platform had been suspected of being dubious for some time. The situation then escalated when it became clear that the platform was brokering non-existent loans to investors, which is a clear indication of a Ponzi scheme. This makes it seem very questionable whether the Corona crisis was the real reason Grupeer had to shut down operations.

But, Grupeer was just a small platform that did not broker nearly as many loans as the 10 largest P2P platforms in Europe.

How the established platforms fared

The top 5 P2P platforms in Europe also had to initially adjust to the Corona crisis.

Mintos experienced some difficulties with various loan originators. Bondora initially had to curb payouts for its core product Bondora Go & Grow because too many investors wanted to withdraw their money. On Twino and PeerBerry, on the other hand, the crisis did not seem to have happened at all; after briefly declining, the number of loans brokered picked up sharply again in the middle of the year.

The hoped-for crash of the major P2P platforms thus failed to materialize. On the contrary, the platforms presented themselves very transparently and were able to demonstrate their resilience to the crisis.

Conclusion: P2P lending is worthwhile

P2P lending conclusion: worthwhile

We admit that we were also skeptical about P2P lending at the beginning and especially questioned where the double-digit returns in this asset class come from. For the major platforms, we then looked in detail at how the loans are brokered. The focus of many platforms on short-term loans then quickly explained how the returns could be achieved.

The established platforms did well to very well during the Corona crisis. We were impressed by how the Corona crisis did not happen on some platforms, so to speak.

Maybe you have been one of the critics in the past, and we would recommend you to reconsider your opinion. In this context, you may find our guide on P2P lending helpful.