Assessing the risks of peer-to-peer lending

A good loan can be hard to find, so borrowers and lenders increasingly are turning to the Internet to find one another. It is important to note though, that online loan “matchmaking,” also known as peer-to-peer lending, social lending, person-to-person lending or P2P, comes with its own unique risks.

Yesterday, the North American Securities Administrators Association (NASAA) released an investor alert and tips to help investors protect themselves, and assess the risks of peer to peer lending. (Before You Invest, as a blog of the Nova Scotia Securities Commission, is an active member of NASAA.)

NASAA’s investor alert urges potential lenders to consider the risk of the borrower defaulting on the loan. Peer-to-peer loans are unsecured; therefore, investors are dependent on the borrower to repay the loan and may have no legal ability to pursue the borrower in the event the borrower fails to pay. The notes issued to the lender are not CDIC-insured, nor are they guaranteed by any federal or provincial agency.

NASAA also advises investors to be aware that the identity of the borrower is often not available to the lender, making it impossible to verify independently the status of the borrower’s finances and business prospects. The lending platform may not do a thorough background check of the borrower, and borrowers may incur additional debts to other lenders.

Like any investment opportunity, when you see a peer-to-peer lending opportunity on the Internet, you should do your homework. Depending on how the loan is set up, you could actually be purchasing a security, not giving a loan. This security would be regulated by provincial securities laws, and the seller would be required to be registered with the Nova Scotia Securities Commission.

“It takes time to fully assess the risks and rewards of financial innovations such as peer-to-peer lending,” said NASAA President and North Carolina Deputy Securities Administrator David Massey. “Investors should proceed with caution when considering new investment vehicles.”

Read NASAA’s investor alert for more information peer-to-peer loans and assessing the risks of lending over the Internet.