The Provision Fund: how it protects your P2P investments
Since 2005 when peer-to-peer lending (P2P) was launched in the UK, some of the UK P2P lending platforms have added an increased level of security to cover losses in case of borrower defaults. Zopa may have led the field in the early days, but in the meantime, more platforms that offer peer-to-peer services have emerged. The peer-to-peer industry is definitely on the rise, with more than 50 P2P platforms registered in the UK. Yet, the key question remains: how can the P2P platforms protect investors from losing their money should a borrower default?
Defining the Provision Fund
RateSetter were the first lending platform to introduce a protective fund, mitigating the risk of an investor losing their money. A provision fund represents the amount of money that is reserved by a P2P lending platform to repay you, the investor, if a borrower is not able to repay their loan. Normally, a provision fund is reserved in cash, but it can also include other assets. By developing a safety net that the platform can use to anticipate unforeseen circumstances, a provision fund enhances a platform’s financial strength.
Investors generally consider P2P lending to be an effective way of earning a higher interest rate than what is offered by traditional investments or banks. In addition, you can better control your investment as the platforms offer transparency that is not always found in other asset classes.
UK P2P Platforms that offer a Provision Fund
In December 2015 €325.4 million new loans were originated from UK P2P platforms. As indicated in the table below, industry leaders are Funding Circle, RateSetter and Zopa with 64%, 67% and 82% YoY increase in loan origination compared to December 2014. Industry leading lenders account for 61.6% of the new loans released in December 2015.
Adapted from http://www.p2p-banking.com/category/countries/uk/
Is my investment guaranteed by the Provision Fund?
There are differences between the provision funds offered by different UK P2P lending platforms. The table below outlines some of these differences so that you know some of the individual fund’s terms, and how, and to what extent, your money is protected.
Most provision funds don’t guarantee coverage in all events and most of them fall under discretionary terms. If several borrowers default simultaneously, then the fund may not be of sufficient size to cover all defaults. It is important that you remain on top of your chosen platform regarding the Ts & Cs, and size, of their provision fund if they have one.
Improvements in the industry, but guarantees are rare!
To anticipate potential losses, RateSetter has recently informed its investors that it will update the legal structure of the provision fund to a limited company, RateSetter Trustee Services Limited. The change aims to increase the level of protection offered to investors as borrowers will continue to pay into the provision fund and the fund will continue to repay investors, should a borrower default. You might be surprised that since their formation in 2010 RateSetter’ investors have not lost a penny. This does not mean that borrowers haven’t defaulted. The reality is, with so many small loans being made in a single investment the provision fund should be of sufficient size to cover individual borrower defaults. Other platforms may not be able to operate such a model.
Regulation of Provision Funds?
Given that P2P lending is still a relatively new asset class, you need to be extremely carefully when reading the terms of a provision fund. The goal is to protect you in case of borrower defaults, and this is the main concern when it comes to investing in a P2P platform. From the regulator’s perspective, the Financial Conduct Authority (FCA) has regulated the industry and ensured that funds in the amount £50,000 is to be reserved by each and every lending platform in the UK, by 2017. Is this enough regulation? That is the question.
