Have you looked at the legal contract for your p2p loan? Is the borrower clearly identified? You may be surprised to find that, in some cases, the supposed borrower is not even mentioned in the contract. So what’s going on? This is known as indirect lending. MoolahSense, Funding Societies and CoAssets use direct lending, while Capital Match and New Union use indirect lending. There is no right or wrong – each lending model has its pros and cons. But if you want to a good p2p investor, you need to know how it affects you…
Direct lending is straightforward
Lenders lend money directly to the SME borrower. The p2p platform is merely an administrator, helping facilitate the transaction between the borrower and lenders. In the contract, the legal responsibilities will be stated as such.
What is Indirect Lending?
Indirect lending happens when investors lend to the SME borrower through the p2p platform itself. The contract will state that the platform (and not the borrower) will make payment to the lenders.
Why would platform do indirect lending?
- When speed is essential. Some platforms does pre-funding first (using their own capital) before opening it up to lenders – which means there are really two transactions taking place: the first between the platform and the borrower, the second between the platform and the lenders.
- To simplify the transaction. Some borrowers prefer to face one collective lender, instead of hundreds of small lenders. If there is any loan restructuring, borrowers will prefer to negotiate with just one collective lender.
- To hide the identity of the borrower. Some borrowers prefer to keep a low profile.
What’s the implications for lenders?
Indirect lending creates additional risks and investors need to focus on two questions:
Is there a real borrower behind the transaction?
In direct lending, the borrower’s name and address are clearly stated in the contract. A lender can go and verify that the borrower is indeed real. But for indirect lending, the borrower’s identity is sometimes not disclosed and known only to the platform itself. How would you know the borrower is repaying early, on time or late? If the platform says the borrower has defaulted, how can you verify that is true? Going one step further, how do you know if there is indeed a real borrower and that it is not a Ponzi scheme like Ezubao? There is no easy solution beyond going to check the physical documents at the platform’s office. Ultimately, lenders need to trust that the platform is doing the right things.
What happens if the p2p platform goes bankrupt?
For direct lending, lenders can still demand direct repayments from the borrowers even if the platform goes bankrupt because the borrowers’ obligations to the lenders are clearly spelt out in the contract. For indirect lending, lenders may not get to claim against the borrowers because the borrowers are not the party to the contract between lenders and the platform.
Conclusion – Indirect lending requires greater trust
There is no right or wrong model for lending. Indirect investment is actually common in equity and real estate crowdfunding. But investors need to be aware that indirect lending means higher risk from the platform itself. As it is not easy to assess the risk of the platform, investors need to trust that the platform is not fraudulent and will not go bankrupt easily. On a personal note, I have loans done on both direct and indirect lending.