Peer-to-peer provision funds compared and explained

12th October 2015
Peer-to-Peer provision funds explained

If you're looking for alternative investment sources for your savings, you may have come across a mention of peer-to-peer platforms. 

Peer to peer can provide a more flexible and profitable way to manage some of your savings when added to your investment portfolio, and many investors may end up with a better service and return than they would with a bank. There can be risks involved, although provision funds and other securities provided by various P2P lenders mean that your money will be protected to a large extent as long as you make sure you know what you're doing. 

This guide can help you to understand exactly what a provision fund is, and whether peer-to-peer saving could be right for you.

What is a provision fund?

A provision fund is a fund established by a peer-to-peer lending platform to safeguard your investments if things go wrong. Peer-to-peer lending means that the middleman, (in this case the bank), is cut out, with individuals lending and borrowing directly to one another through provider platforms. This can mean higher returns of investment and a great way for individuals and small businesses to get loans. However the Peer-to-peer industry is not covered by the Financial Services Compensation Scheme (FSCS). As a result, platform provision funds typically provide the security for investors instead.

Why do peer-to-peer platforms use provision funds?

Since there is no FSCS protection for investors investing in peer to peer, a natural concern is repayment in case of a default. This is negated by using the provision fund to ensure you are compensated and get your capital and interest back. Most companies offering peer-to-peer lending, like RateSetter, have such a fund which can easily be tracked and monitored by users. 

Fees paid by borrowers help to maintain the fund, and it can't be used by the company for any purpose other than compensating investors when something goes wrong. This means that you'll get that additional level of security thrown in. For example, in the case of RateSetter, they have successfully returned 100% of capital and interest to date with no draws on the provision fund.

If a platform doesn't have a provision fund should it be avoided?

Not necessarily. A platform without a provision fund might take another form of security from a borrower, such as an asset or first charge on a property. Some companies, like Upstart, don't provide such security, but use highly-detailed data analysis to gauge the risk of each lender defaulting on the loan. Higher risks can mean higher interest rates, so some investors prefer this flexibility, but investments such as these can be best as part of a larger portfolio, never to solely be relied upon or somewhere to stash your life savings. In addition, there are other methods besides provision funds that can help to safeguard lenders' investments. 

What to look for in a provision fund

Most companies will publish the details of their provision fund so that lenders can see how much money is backing up their investments, and others will also disclose default rates, and how much capital and interest has been returned through their platform so far. These can be good signs to back up a secure lending option, while additional measures such as insurance and asset-backed lending can give an extra layer of security to any lenders. 

Provision funds maintained at a rate of annualised instalments are also a good sign, with higher rates offering more security. You should also check that the provision fund is legally ring-fenced, so that it can't be used for any other purpose by the company that runs the platform.

Security provided by platforms

As well as provision funds, certain other measures to safeguard investments are in place. Some companies, like Upstart, give highly-detailed risk assessments of borrowers so lenders can make the decision themselves. Others, such as Wellesley & Co., run provision funds but also back up their loans with assets, which can then be sold to cover claims in the event of the provision fund proving insufficient. Others, such as Lending Works, take out insurance against borrower default, and others simply encourage investors to spread the risk along a range of different investments. 

With the number of peer-to-peer lending companies growing hugely in recent years, there's a huge variety of choice out there, and when it comes to security, just like anything else, the choice is down to the consumer after consulting each companies' individual systems.

Download the guide and take it with you wherever you go.

Your capital is at risk if you lend to businesses. Peer to peer lending is not protected by the Financial Services Compensation Scheme. Please read our full risk warning here.