The Four-Letter Word in Investment – RISK

Risk. It’s a word that you’ll see plastered over many investment sites, documents and posters (if properly prepared). Regulators worry about investors misunderstanding risk. But its actually the relationship between risk and reward that investors need to understand…  

In this article, we cover what this four-letter word means in Peer-to-Peer lending and, more specifically, what it means on and how we as a P2P platform inform you about the risks involved.  

Outside of the world of finance and investment, everyone understands what risk is and how various things can impact on their everyday lives. If you smoke, you’re at a higher risk of getting cancer, if you speed you are at risk of an accident or fine. Risk is about balancing the potential gains / benefits or enjoyment of something against the potential downsides and repercussions.  Specific actions carry specific and varying risks.  

In investment terms, risk can be defined as the relationship between ambition to earn more and fear. If you are fearful of loss, you are more likely to be risk-averse. When our ambition overcomes our fear, we are likely to take more risk. It’s a moving target, which leads to macro-economic cycles of confidence.

Often, many people assume that the risks across P2P lending are the same. To some extent, there are similarities, i.e. the risk is not getting repaid, this is known as Capital Risk. However the reasons arising from an inability to repay vary significantly.

Risk in Peer to Business Lending 

When investing on you’re participating in debt arrangements (or loans) with UK businesses, rather than individuals.  

To really understand the risk involved when lending to businesses, we have to understand the risks faced by the businesses themselves.  

For a business to be able to repay you, it needs to continue trading well enough to be able to afford the repayments as and when they fall due. Businesses face a significant number of challenges every day that affect their ability to continue trading. Think risk from their own markets from competitors ( think Blockbuster), to risks associated with their suppliers (think hotels affected by Thomas Cook) to broader economic risks,(yes you got it, Brexit).  

The above examples are primarily of large firms failing, when lending on you’re supporting much smaller businesses that are often family-run, so they may also be vulnerable to the effects personal issues may have on their business, consider how a serious illness or death in the family might affect a small business. 

So, if a business’s ability to repay their loans in a timely manner is affected, you may:  

  • Receive repayments later than expected 
  • Not receive interest on your money for a short period 
  • Lose all the money you lent the business 

What about the platform ?

Now, don’t forget, is also a business, as is every investment firm to one extent or another, and as such is not immune from many of the same risks that affect the borrowers on the platform. But you’re not lending to us, so how does that affect you?  

The risk associated with using P2P platforms (or any investment firm) is called Platform Risk

This essentially covers what would happen if we as a business were no longer able to trade. What would happen to your funds, your unrepaid loans etc, etc.  

Fortunately, as a regulated firm, we’re required to have, what the regulator calls, ‘an orderly wind-down arrangement’ or living will in place. This essentially sets out how we plan to ensure that you’ll still be able to withdraw funds and who will ensure that borrowers continue to honour their agreements.  

From watching what has happened during the orderly wind-down of some other firms in the industry, it is anticipated that regardless of the strength of the plan, you are likely to experience some delay in being able to withdraw your liquid funds from the platforms, whilst the ‘wind-down partner’ / regulator gets up to speed with how the platform processes work etc.  

In regard to your liquid funds, these are always held in a segregated client account, completely separate from our own firm’s funds.  

Navigating Risk on 

Over the years we’ve put a lot of work into making it as easy as possible for you to identify the risks associated with each individual loan if you’re lending manually, as well as making significant changes to the auto-bidding tool, BidPal so you can tailor your settings to your risk appetite.  

Individual Loan Profiles 

We believe that our loan profiles are unrivaled in the industry in terms of the depth information shown to lenders and the ‘easy to understand’ way in which it is set out. 

Not only do we show the risk rating of the particular loan, but we also show you the historic bad debt and default rates of similar loans in the past.  

We also highlight key risk factors that our credit risk team have identified in their analysis and give you detailed information on the security on each loan. And if you still need more information, you can ask the borrower directly through the discussion forum.  

Find out more about our detailed loan profiles!

Auto lending 

BidPal allows you to be as specific (or not) as you like, when setting your auto investment criteria. Just set the risk rating and interest rate, and go, or drill down and exclude regions or different business sectors entirely.  

Your money, your risk choices! 

Mitigating Risk  

Risk Mitigation means what you can do to reduce your overall risk when investing.

Lending at risk-adjusted rates is also a good way in which to mitigate the risk. This means that if you think a business is a higher risk investment than another, consider lending at a higher rate to offset the potential capital losses.  

On we help you reduce your risk, with the BuyBack Guarantee. The BuyBack Guarantee is available only on loans in the secondary market. These loans are sold by High Net Worth and Sophisticated investors and are sold to you at a premium. They can demand this premium as they essentially hold the risk for the life of the loan. If the loan falls into arrears or defaults they will buy it back from you and carry the capital risk. So, by buying a microloan with a BuyBack Guarantee, you might earn less interest, but you’ll also have less risk, again the risk-reward conundrum.  

Another way to mitigate your risk in Peer-to-Business lending is to build a diversified portfolio. This means, lending to a wide variety of business sectors and risk profiles. generates ongoing compounded returns for lenders with monthly yields. It should be viewed as a medium to long term investment strategy to help build up a passive income or increase your savings for the future, whether it be retirement or a house deposit.  

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