The Securities Exchange Commission in cooperation with the North American Securities Administrators Association (NASAA) have issued warnings to investors about the risks of peer-to-peer lending via the Web.
In the current economic environment where it is often difficult to obtain a conventional loan from banks, peer-to-peer lending or P2P, has become popular. Peer-to-peer lending allows individuals and small businesses to use an intermediary to obtain loans over the internet from other internet users. This type of social lending, or online loan matchmaking, invites investors to fund these loans based on the promise of a steady above average capital return. P2P intermediary firms, such as Lending Club, tell investors the pool of loans which they are buying into could yield about 12%, but because borrowers could default on their loans, to be expecting more like 9%.
Unfortunately, the P2P process doesn’t always work the way it’s supposed to and regulation of peer-to-peer lending is murky, according to David Massey, president of NASAA. Regulators in Nevada have found instances in which a P2P lender did not register its products and cases in which some P2P lending schemes were simply criminal scams.
Since peer-to-peer lending is a business model that is still emerging, investors should carefully consider the risks before getting involved in a peer-to-peer lending opportunity on the internet. Mr. Massey said that when problems arise with P2P notes, it’s often due to the fact that than a P2P intermediary handles the transactions, in which cases the borrower and the lender never have direct contact. The investor does not know the identity of the borrower and cannot verify independently any financial or business information the borrower may have provided. Although intermediaries such as Lending Club try to limit risk by examining borrowers’ credit ratings and bankruptcy reports, borrower’s income is verified only on larger loans, said the intermediary’s founder and chief executive, Renaud Laplanche. According to the NASAA, default rates on P2P loans may be unusually high, exceeding 25 percent on some platforms.
In addition to the risk of borrowers defaulting on the loan, investors’ may have little to no legal ability to pursue the borrower in the event of a default as the loans themselves are unsecured. The notes issued to the investor are also not insured with the Federal Deposit Insurance Corp. (FDIC), nor are they guaranteed by any other state or federal agency.
The Dodd-Frank Wall Street Reform and Consumer Protection Act has mandated for a one year study of the regulatory framework for peer-to-peer lending which is due in July. Peer-to-peer lending may be regulated by the Securities and Exchange Commission, state securities regulators or state banking regulators because their lending platforms often involve both loans and securities.
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