P2P lending: What is it and how does it work?

By Grace Ormsby

October 29 2019
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Peer-to-peer lending (P2P lending) is a relatively new form of investment in Australia, so to explain the concept and how it actually works, we’ve enlisted the help of one such platform’s CEO.

According to John Baini, co-founder and CEO of TruePillars, P2P lending occurs where a central platform acts effectively as “an introducer between parties that want to borrow money and parties who are looking to invest and earn a return”.

P2P lending effectively sees the platform operator “disintermediating” a loan which is then required to be paid back to the investor with interest.

Mr Baini explained it as “cutting out the middle man” that in this case would normally be a bank.

“Banks use deposit funds to fund loans or even borrow money to fund loans and the outcome of which is that the depositor gets quite a small return, whereas the bank is taking a lion’s share of the interest that those borrowers are paying,” he said.

“What a peer-to-peer lender does is effectively cut that step out and allow the bulk of the interest borrowers are paying on loans to flow through to those investors.”

For the CEO, “that’s clearly the positive point of difference, so the return is therefore greatly enhanced”.

The advantages also flow through to the businesses and companies who go to TruePillars to take out a loan, Mr Baini also highlighted.

“The main advantage for businesses is we are a lot more attentive and a lot faster in response to their lending needs,” the CEO said.

“Small business lending is one of the more complicated forms of lending because the information surrounding small businesses is quite imperfect.”

Mr Baini noted that “from a credit assessment standpoint, if you are looking at a very large corporate, their accounts are normally audited by a big four accounting firm [and] the numbers are considered reliable”.

“The same doesn’t apply at small business level – so, it is a more complicated and risky form of credit, and therefore, banks will generally take quite long and have quite a limited appetite for lending to small businesses.”

He said that for each business applying for a loan, there’s a series of checks that include looking at the credit history of the business as well as the owners.

Bank statements are also provided “to get a very quick and detailed insight into what’s actually going through their bank accounts”.

“If the application passes all of those hurdles that we set, we then go into further detail in things like their financial statements, we usually talk to the borrower and get a feel for how well they understand their business, and then if we are happy to approve the loan, we make it available on our website and we share some of this information with our investors,” Mr Baini set out.

“Albeit, we don’t actually identify the borrower [to the investor pool].

“It’s a trade-off of sorts whereby protecting the anonymity of the borrower.”

Mr Baini justified this action as helpful for putting businesses “in a mindset where they are happy for information about their business to be shared with our investors”.

On the other hand, better returns do obviously carry greater risk.

With a bank, you are capital-protected through the government guarantee up to $250,000.

But with P2P companies and certainly in the case of TruePillars, “the investors have to take the risk of the borrowers defaulting”.

To better spread out such risks and provide safer returns for investors, the platform has harnessed technology to fractionalise the loan it offers.

“The opportunity for the investor is to take a small piece of that loan, starting at a minimum of just $50.

“We make it very easy for these investors to spread money across a large number of loans rather than being required to fund a whole loan, and that therefore is a way of limiting their exposure to a borrower default.”

Giving the example of provision of a $100,000 loan for a business, Mr Baini said: “Generally speaking, we would have more than 250 different investors fund that loan, but from the business’s point of view, you can’t have relationships with 250 parties.

“All it wants to do is make a single monthly repayment.

“We then need technology to sit behind that and split that single payment into 250 different ‘bits’, and again, that just wouldn’t be possible running from a spreadsheet because you’d have some investors who would put $10,000 into that loan and some who put $50, so our technology needs to calculate how much of each payment goes to each investor.

“It enables us to be fast and convenient for borrowers – and without the tech on the investor side – you just wouldn’t be able to offer the service that we do.”

About the author

Grace Ormsby

Grace is a journalist on Momentum Media's nestegg. She enjoys being able to provide easy to digest information and practical tips for Australians with regard to their wealth, as well as having a platform on which to engage leading experts and commentators and leverage their insight.

About the author

Grace Ormsby

Grace is a journalist on Momentum Media's nestegg. She enjoys being able to provide easy to digest information and practical tips for Australians with regard to their wealth, as well as having a platform on which to engage leading experts and commentators and leverage their insight.

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