Last month we wrote about the growing global phenomenon of peer-to-peer social lending, which links borrowers and lenders directly, bypassing banks and their fees. RainFin, which was the first peer-to-peer online lending platform in South Africa, announced recently that after being in the market for two years they are now listing around 18 new loans every day for investors to bid on, at a total loan value of around R400 000. This impressive growth caught the attention of international heavyweight, Barclays Africa, which acquired 49% of RainFin’s business in March 2014 and is also now an active lender on the marketplace.

Peer-to-peer lending is a similar concept to crowdsourcing except that instead of a business proposal, a borrower lists needs for a personal loan and investors decide if they want to commit funds based on a specific return rate. In the US peer-to-peer marketplaces will facilitate roughly $5bn this year, but at less than 40% of the operating costs per loan granted compared to traditional banks, according to Sean Emery, CEO of online lender RainFin.

It is not however a solution for borrowers with poor credit records. Although RainFin has a registrant rate of 350 customers per day representing an average R7 500 000 in loan value, less than 10% of these applications pass screening after undergoing a detailed moderation, scoring and affordability assessment.

Is it an attractive offering for investors?

Peer-to-peer lending models are certainly a cost-effective way for borrowers with good credit records to access finance, but are they paying sufficiently high enough returns for individuals to take the risk in investing in these loans?

RainFin claims that they have created the business to allow investors to receive returns comparative or better than RSA retail bonds. Emery says that given their excellent management of impairments (non-paying loans) the worst-case scenario for investors with significant impairment will bring their returns back to levels compared to that of retail bonds.

Although investors are encouraged to spread their investments across several loans (up to 100 is permitted by the Financial Services Board) it is still a higher risk than investing in a bank account or an RSA retail bond, where the risks are significantly lower as you are not exposed to the risk of potential default. Peer-to-peer lending increases that risk.

Emery counters that peer-to-peer lending in itself is not a high-risk category although the individual loans or assets within peer-to-peer could be high risk. RainFin grades the various loan applications according to a risk profile and investors can decide what level of risk and return they wish to take. The higher the risk of the loan defaulting, the higher the potential return to the investor – so the risk is highly dependent on the investor and the choices they make on the platform.

As an investor you need to understand the risk implications of opting for higher returns. For example an investor in a Grade A risk profile, with a potential default rate 0.41%, would receive a return of 10% over the period of the loan while an investor in a higher-risk Grade C loan with a default rate of 6.6%, would receive a 20% return over the period of the loan.

It is important to understand the nature of the loan repayment which is monthly – therefore an investor receives a monthly income which includes a portion of the capital invested as well as interest earned. As the interest is charged on a reducing balance one cannot make a direct comparison to a normal fixed deposit – the actual interest rate received is not a per annum rate. The investor will receive a detailed repayment schedule in order to enable him or her to make informed decisions when investing into a specific loan.

For example if you invested R10 000 into a Grade A loan with a 10% return over two years you would receive R461 per month or R11 064 total return of capital and interest – that is a return of 11% over two years.

These are not particularly high returns and one would need to take increased risk to receive returns above what the market currently offers.

There is however the aspect of social sharing – research and experience has shown that people prefer to borrow and lend to their community directly rather than using the bank which is often seen as an unfavourable ‘middle-man’ who limits access to funds and charges excessive fees.

For investors who have an appetite for risk and can afford to experience some loss or reduction in return, the higher-risk loans could be an interesting option. This is also an option for an investor who would like a similar return to a fixed deposit but prefers the concept of social sharing and supporting the growth of peer-to-peer lending as an alternative to banks dominating the lending and borrowing space.

Who can borrow?

• Must be an SA Citizen
• At least 18 years old
• Min Delphi score of 600 from Experian (credit bureau)
• Debt-to-income ratio of 60% including mortgage
• At least two current open credit accounts reporting consumer behaviour
• Five or fewer account enquiries in the last three months
• Mininmum credit history of 24 months

This article first appeared in City Press