Indians have traditionally preferred to invest their money in fixed deposits, realty, gold, post office schemes and in the past few years in the equity market. But an up-and-coming asset class that’s been hogging significant limelight is peer-to-peer lending or commonly known as P2P lending. While returns from the traditional investments have either been dismal or volatile, as in the case of equities, P2P lending has gained traction as an investment tool for steady returns for risk-taking individuals.
WHAT IS P2P LENDING?
Think of a Flipkart which provides a common platform for buyers to check products sold by the sellers who either make or market those products. In P2P lending, buyer is the borrower who wants to avail of a loan, whereas seller is the lender who will give money to the borrower for a pre-decided interest rate and tenure. It is a platform where a person who needs short-term personal loans can connect with a person, who is willing to give the loan at a certain interest rate. There are numerous platforms available online that help match borrowers with lenders.
IS P2P LENDING REGULATED BY RBI?
Globally, P2P lending came into existence 8-10 years ago, but it picked up momentum in India in the last two-three years. The Reserve Bank of India (RBI) was quick to take note of the popularity of P2P lending platforms and the growth in loan books of online market lenders which were not under any regulations. On October 4, 2017, the RBI released guidelines and final regulatory framework for P2P lending in India where companies involved in it will have to get NBFC-P2P license and will fall under the ambit of RBI regulations.
RISK FACTOR IN P2P LENDING
P2P lending involves risk of loans getting default, so yes it comes with risk. To combat this risk, online platform providers or market lenders provide certain information and checks to gauge a borrower’s default risk. A screener allows you to select borrowers based on his/her risk profile, financial position, current outstanding loans and repayment history. Credit score of borrower, collections support and insurance schemes to protect lender’s principal loan amount against any event-based risk are other features provided by P2P platforms.
After the RBI’s regulations on P2P lending, the platform providers need to submit all loan-related data to RBI, including loan defaults. This, in turn, will impact the credit score of the borrower if he/she defaults or repays loans with a delay.
HOW IS MONEY EXCHANGED?
Although the entire process is digital, RBI has made it mandatory for the platforms to maintain an escrow account. The escrow account is a holding account which manages the flow of funds between borrower and lender in a P2P environment. The lenders’ funds are held in escrow account from which the loan amount is transferred to the borrower. The loan repayment amount, collected every month from borrower, is also maintained in the same account. Thus, escrow accounts ensure that funds are not misused by the lending platforms.
Returns generated from a P2P lending portfolio depends on three factors — interest rates, loan tenure and repayment performance of borrowers. Banks can offer loans to multiple customers. Similarly, a lender in P2P lending can give loans to multiple borrowers to reduce risk.
Vinaya, who recently joined a P2P lending platform as lender with a capital of Rs 1 lakh can either give loan of Rs 1 lakh to one borrower or she can give four loans of Rs 25,000 each to four borrowers. By giving loans to four people, she has effectively reduced her loan-default risk. P2P lending allows you to build a portfolio of loans consisting of low, medium and high-risk loans based on your risk-return appetite.
P2P lending is a good platform to help connect lenders with borrowers and where both parties can benefit from the platform. A lender can earn interest on his/her loaned amount, which is higher than fixed deposit interest, while the borrower can get loans easily, as compared with the tedious banking loan procedures.
Though it’s a great concept which benefits all, one must take the loan default risk into consideration before trying their hands on P2P lending.