P2P Lending In India | Rise, Regulations And Risks

 

Peer-to-peer (P2P) lending is often called the sunrise sector in the Indian financial sector landscape due to its growth of 10 times in the last year on a year-on-year basis. Growth was brought in by the recognition from the Reserve Bank of India, which regulates the entire sector under a separate category called P2P NBFC. Due to relaxed norms back in December 2019, with the increase in individual lending limits across platforms from ₹10 lakhs to ₹50 lakhs. An average return of 12 to 14 percent in a year, is a rate that excites the investors. The lenders on the P2P lending platforms had earned in the covid pandemic stricken year. Nearly 4,50,000 new lenders have joined a P2P platform in FY21 as compared to just 50,000 registered lenders at the end of FY20. The total count of registered lenders on the platform is 5,00,000, which in statistics is a jump of 900% in a year.

These platforms act as a conduit between lenders and borrowers, that could be either be individuals or micro SMEs. An investor who has surplus capital and looking for a short-term investment may invest and lend money to borrowers.

Regulation of P2P Lending space in India

The regulation of the entire space is done by the Reserve bank of India by the Master Directions – Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve bank) Directions, 2017.[1]

According to the Master Directions under Section 4 (1) (v), it defines, P2P Lending platform as:

”Peer to Peer Lending Platform” means an intermediary providing the services of loan facilitation via online medium or otherwise, to the participants as defined at Item (iv) of subparagraph (1) of paragraph 4 of these directions;”[2]

It states that apart from a company, no non-banking institution can undertake the business of a P2P lending platform.[3]And any NBFC intending to start the business of P2P (NBFC P2P) lending is to do the same by obtaining a Certificate of Recognition (CoR) from the RBI.[4]The amendments are made in the Master Direction, in which, the last was done in December 2019.

Compliance for NBFC-P2P, borrowers, and lenders

The directions state that the NBFC-P2P has to undertake due diligence on borrowers and lenders.[5]And it is obligated to undertake credit assessments and risk profiling of the borrowers and lenders.[6]They require the prior and explicit consent of the participant to access its credit information.[7]Apart from these, NBFC-P2P also has to undertake documentation of loan agreements and other related documents, assist in disbursement and repayments of the loan amount, render services for recovery of loans originated on the platform. The NBFC-P2P must maintain a Leverage Ratio not exceeding 2. They are expected to follow the Fair Practise Code, as prescribed by RBI often.

For the borrowers, it does not provide any specific instructions or compliances that have to be observed. Though from the master directions, there are certain practical considerations that the borrowers must ponder over prior to borrowing a loan from NBFC-P2P. The major requirement or expectation from a borrower is to undertake their fair share of due diligence of the lending platform before borrowing the amount. The aggregate loans taken by a borrower at any point of time, across all P2Ps, shall be subject to a cap of ₹10,00,000/-.[8]And the maturity of the loans shall not exceed 36 months.[9]They should be transparent and ethical in terms of the information given to the lending platform.

For the lenders, the aggregate exposure of a lender to all borrowers at any point of time, across all P2P platforms, shall be ₹50,00,000/- provided that such investments of the lenders on P2P platforms are consistent with their net-worth.The lender investing more than ₹10,00,000 across P2P platforms would have to produce a certificate to P2P platforms from a practicing Chartered Accountant certifying a minimum networth of ₹50,00,000.[10]And the exposure of a single lender to the same borrower, across all P2Ps, shall not exceed ₹50,000/-.

Other guidelines such as Fund Transfer mechanism and Interest rate are also mentioned in the

Master Directions. All the fund transfers between participants of the platform are to be done

through escrow accounts that are operated through bank-promoted trustees.

The interest rates should be annualized percentage rate format.

The high returns should not be taken as a one-sided story of a treasure that gives out various returns, because this space has its downsides and risks involved like any other space.

One platform reported 6-7 percent NPA on books, while it was 3.94% percent for another one. The platform is not for everyone, rather for sophisticated investors, as the regulations have a cap of ₹50,000 investment for a lender so that the money can be diversified. On paper, it has the potential to solve India’s problem of financial inclusion, but problems of minimal collateral, lack of credit history, and absence of point of sales need to be solved. The dependence of the entire platform is on smartphone penetration, the attraction of risk-taking lenders, robustness of the platform’s credit risk analytics, the authenticity of identity, and the detection and solution to fraudulent activities.

Chinese Fiasco

The trend of P2P lending is not new to the world. It was picked up in China after its global success, the statistics grew from 50 to 3,500 from 2011 to 2015 with outstanding loans of $192 billion and 50 million users, which was the largest in the world. In 2016, the Chinese Banking Regulatory Commission showed that around 40% of platforms were elaborated Ponzi schemes, which led to tightening of regulations, which again led to the closure of around 4,500 platforms since 2013. Though India having stricter regulations and cappings and having a different business model, wherein in China, the lender would lend them money, disbursing to the platform, which would distribute to the borrowers. Whereas in India, decentralization has paved a way to remove the mediators. This shields platforms from the risks this sector poses.

Rise of decentralization

The P2P lending platforms provide an alternative to traditional banks and societies for obtaining finances. The concept of P2P Lending involves the removal of centralized financial institutions from the process of lending and borrowing of funds. The route enables fundraising directly without intermediaries. It acts as marketplaces or aggregators bringing together lenders/investors and borrowers on online channels. Though the superficial concept of the cryptocurrencies or NFTs and P2P lending are different the core concept remains the same which is decentralization, public governance, participation, equity, and interaction.

Fintechs revamping the space

Recently, big fintech companies are looking at P2P lending as a tool to engage with an interactive consumer base. BharatPe and Cred have launched offerings around this risky asset class for the customers, that allows the consumers to earn and borrow at competitive market rates.

BharatPe had offered and launched a P2P offering called the 12% Club that allows its customers to lend and borrow at 12% interest rates on their investments and borrowings respectively. They launched a separate app for this P2P offering service. Earlier which was limited due to the high customer acquisition cost required to build supply and demand, but now due to adaptation by BharatPe and Cred, it would become mainstream. 

Cred launched a similar offering to a user base of 7.5 million with 750+ credit scores to borrow and lend at 9% and 12-15% interest. They have also collaborated with smaller companies to get access to a larger consumer base, which helps to increase the credibility, trust, and awareness of the sector.

The fintech space in India is on a boom, and it’s expanding like its own universe due to the pandemic, which has revolutionized a digital space pulling up from traditional lending and borrowing. The upside of P2P lending is its easy availability, easier compliance, less paperwork. However, any space comes with its risks which we have discussed above and the participants have to be aware of the same. The digitalization of the peer to peer lending is here to stay with more and better regulations and evolutions in the ecosystem, paving a way for greater collaborations and mutual benefits.