09 - 03 - 2016 | |
Just last week, UOB announced that they would be investing S$14 million into a global equity crowdfunding platform, OurCrowd.
For those who are not familiar with this type of lending, borrowing and funding, this is a relatively new type of peer-to-peer lending/funding, which in our opinion, would represent one of the key future of our banking industry.
To better understand how this industry works, let’s first review what commercial banks do.
One of the key functions of commercial banks like DBS, UOB and OCBC is to act as a financial intermediary between lenders and borrowers. Lenders represent people who have excess money, and who would like to keep their money in the bank account for safekeeping and to earn an interest. Borrowers represent those who are in need of funding. This could include companies such as Small Medium Enterprise (SMEs).
Instead of lending your money to a bank at a low interest rate, only for the bank to lend out the same money you gave them to an SME at a much higher interest rate, peer-to-peer (P2P) lending allows you to lend directly to the company that you want to lend it to, at a much higher interest rate than you would ever be able to attain from a bank.
DollarsAndSense.sg have been covering the P2P industry for some time and we understand that there are some differences in terms of the investing mechanism for investors. This can come in the form of equity and debt.
P2P lending allows investors to lend money directly to borrowers. In Singapore, these borrowers are typically SMEs. We understand that for P2P lending platform such as Funding Societies, lenders can expect a return of about 12% – 16% per annum. Other platforms such as Capital Match also provide similar returns. Loan duration are usually about 6 months to 2 years.
From our discussion with these companies, we also understand that most of the borrowers accept onto their platform are established SMEs that have stable revenue. However, some of these companies may have insufficient credit history to be able to secure loans or credit lines from commercial banks. As such, they rely on P2P lending to help them with their short-term cashflow needs.
There is no question on the risk involved with P2P lending. The risk-return tradeoff theory states that you cannot expect higher returns without taking on a greater risk. When you lend to a commercial bank like UOB, the risk of you not getting your money back is extremely low which coincides with the extremely low returns you get. When you lend to an SME directly, there is a much greater risk of default that you bear in return for the high returns that you enjoy.
Think of equity crowdfunding as an episode of the Shark Tank or Dragons’ Den. Interested investors can purchase equity in a business of their choice as long as they are willing to meet the business owner’s asking price. In return, they get to enjoy the upside if the business performs well.
Common senses would suggest that P2P equity crowdfunding would be more risky than debt lending because there is no legal obligation for the money invested to be returned. In addition, companies that are willing to give up equity in return for investment are usually those in the start-up phase who still do not have a steady stream of revenue.
If this is your first time reading about P2P lending, it would be normal to feel slightly sceptical. People should never compare lending money to SMEs as the same thing as lending money to an established commercial bank like UOB.
However, the fact that UOB has invested money into an equity crowdfunding platform and intends to open it up to some of their valuable accredited UOB clients, it shows that the company is expanding its product range to suit its customer’s needs. These savvy investors are no longer satisfied to simply give their money to UOB and allow the banks to dictate where their money would go and the returns they should get.
Rather, they want to have choices and the banks are looking to provide their service by giving their clients these choices.
We want to debunk a myth before we conclude this article. Just because a local bank finally joined the P2P lending & funding scene, it does not make this sector any safer or riskier than it used to be. The risk exposure is similar as before.
The only thing it means is that the sector has now grown to a size that the local banks can no longer ignore. They either have to join in, or watch the boat sail by without them.
For a new sector like this, we think that by looking into the debt lending and being assured of a fixed return over a period of 6 months to 2 years is a lot safer than making equity investments into companies. Having said that, this is a sector where interested investors will need to go in well informed.
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