Here’s what an insider says about the crowdfunding industry in Singapore: overheated and negative competition.
Crowdfunding companies are often saying how quickly they can fund a loan or how crowdfunding is going to disrupt banking. Rarely do we see an industry insider talking about the dark side of crowdfunding.
So when Funding Societies co-founder, Kelvin Teo, talks about the issues within the crowdfunding industry in a recent Business Times article, all investors should pay attention.
Excessive, negative competition
According to Kelvin Teo, there are far too many new players, resulting in plenty of negative competition.
“We’ve seen cases where we’ve crowdfunded a loan, and the loan agreement goes out with the identity of the borrower. One week later, another platform gives additional loans to the SMEs, which increases credit exposure and hence risk for investors.”
The number of crowdfunding platforms has increased rapidly over the past 12 months. At the same time, we keep seeing the same borrowers on different crowdfunding platforms, often taking up new loans when they have not completed their repayment on previous loans.
This phenomenon is known as loan stacking. But we prefer to call it “merry-go-round” lending.
This is like borrowing from Paul to repay Peter, then borrowing from Peter to repay Patrick. Basically, these borrowers are not generating enough cashflow to pay down their debts, and are merely using new debts to cover old debts.
This is a worrying trend. Because if the business deteriorates or if the next loan is not forthcoming, the borrower will just go bust. Just like what happened to Swiber. Or Lehman Brothers.
Has the loan defaulted or not?
The second issue is the question of whether a loan has defaulted or not. Default definitions vary across platforms, making comparison impossible.
“There are many ways to define and window-dress defaults,” said Mr Teo. “Platforms don’t always disclose, making it difficult to compare performance. Sometimes, even investors themselves don’t know the status of their loans. This increases the risk of fraud,” he said.
We can’t agree more. We’ve seen several cases of window-dressing – restructuring bad loans to make them look good.
This defy common sense. Of course, restructured loans have already defaulted. If the loans are good, would there be a need to restructure the payment terms?
So what should p2p investors do?
Faced with these issues, investors should definitely pay more attention on due diligence and risk management.
Due diligence refers to doing sufficient checks on the crowdfunding platform and borrower. Ask basic questions – Where is the money from repayment coming from? What are your previous professional experiences? If you are not satisfied with the answers, don’t invest. If you are still unsure, you may want to dig deeper – do read our previous post on how to do so.
Risk management is about controlling the amount of risks undertaken. Don’t invest all your money in a single loan with a single crowdfunding platform. Always try to build a diversified portfolio. Our P2P portfolio has 40 loans, ranging from $200 to $2,000 per loan. A couple of defaults won’t damage our entire portfolio too badly.
An important point about diversification – always plan ahead. If you intend to have a diversified portfolio of 30 loans and the minimum loan amount is $3,000 per loan, then you will need to have $90k. If you don’t have $90k, then your portfolio will be highly concentrated. Concentrated bets sometimes do work, but it is a strategy for experienced investors.
The other option is to find another platform with lower minimum loan amount.
Otherwise, just don’t invest.
Sometimes not investing is a better option than putting big sums of money behind a single p2p loan.