PEER-TO-PEER lenders should not use provision funds, a P2P investment manager has argued in a new report.
BondMason claims the funds, used by platforms such as Zopa and RateSetter, are just a tool to attract lenders.
The provision fund is a pot of money set aside to compensate lenders, if default rates increase more than expected.
The investment firm, which aims to get clients a seven per cent return by selecting P2P loans across approved platforms on their behalf, argues that provision funds “do little (nothing) to improve returns for well-diversified investors.”
“Provision funds provide an illusion of protection but reduce lending returns in every scenario for well diversified lenders,” the report said.
Stephen Findlay, chief executive of BondMason told Peer-to-Peer Finance News that if a provision fund is over or under-funded, in both situations the lender loses out.
“If a provision fund is over-funded that money could be going towards lender returns instead, and if it is underfunded investors have lost that return.”
This was rejected by RateSetter.
“A well-run contingency pot such as the provision fund is a fast, simple and effective way of ensuring diversification and greater predictability of returns for retail investors,” the platform said in a statement.
“RateSetter investors automatically benefit from the provision fund – this means that investors are not exposed to the performance of any individual loan, they are instead exposed to the performance of the entire loan book of hundreds of thousands of diverse loans, without having to take any manual steps themselves to achieve this.
“Additionally, it has ensured that to date, no individual investor has ever lost a penny, although of course this is not a guarantee for the future.”
Looking at the wider market, the BondMason report found lending in the P2P market grew by 39 per cent in 2016 to £3.2bn but warned that this was down from the annual growth of 91 per cent between 2014 and 2015.
Using the Gartner Hype Cycle, which looks at the various points in the market for emerging technologies, the report claims P2P lending is at the “peak of inflated expectations” phase.
This comes after the first point which is the trigger phase.
After the “peak of inflated expectations,” the market typically enters a dip into the “trough of disillusionment.”
This is the period where the leading participants become more robust and the weaker ones exit by being outcompeted, through regulation or general failure.
The next stage in the cycle is a boost in growth to the “slope of enlightenment,” which then sees the market grow and settle at a plateau of productivity.
As the sector heads towards the next phase, the report warns there are signs of lender interest falling, based on Google searches for P2P lending dropping.
Platforms will instead need to focus on getting quality borrowers, according to the research, which it says will create a “flight to quality.”
The report predicts increased competition, mergers, banking partnerships and even a notable platform failure as it becomes harder for platforms to sustain revenues to cover their cost base.
This is attributed to platforms all using the same methods to find borrowers, which the report says may see loan rates fall.
“The P2P industry continues to grow at an impressive rate,” Findlay said.
“What we are seeing right now, and what we believe to be the reason for the slow-down, is the start of a ‘flight to quality’ whereby better lending platforms outperform and evolve faster and more sustainably than weaker ones, forcing the underperforming platforms to start to lose market share and then move out of the market altogether. This is good news for lenders, for borrowers and, ultimately, for the market itself.”