Peer-to-peer (P2P) lending: A new lending and borrowing option to explore

Peer-to-peer lending is gaining popularity in India, as it helps people who have idle cash to invest and also those with low credit scores.

In late August 2018, Indian media reports spoke of 16 licensed peer-to-peer lending (P2P Lending) start-ups appealing to the country’s apex bank, the RBI, for an increase in their lending limit and a relaxation of the RBI guidelines that bind their operations.

According to the reports, this group said the biggest challenge being faced by their nascent industry was the lender limit of Rs 10 lakh. This, they argued, was threatening the very existence of the lending start-ups. 

The group also felt that by raising the limit to Rs 1 crore for retail investors, RBI would be allowing high net-worth individuals to enter the sector as lenders. This would infuse the much-needed capital in the start-up ecosystem. 

At the time of writing, RBI had not responded. However, the fact that the country’s monetary regulator is involved in framing rules for peer-to-peer lending platforms reflects the importance of this sector and its increasing impact. 

The question that may arise is, what exactly is peer-to-peer lending, and why does one need this when we have banks and traditional NBFCs? 

Concept & Definition

Peer-to-peer or P2P lending is a new alternative form of lending that is fast gaining ground in India. It is different from taking out a loan from the bank in the traditional way.

In its most basic definition, P2P lending is the practice of lending money to individuals or businesses through online platforms or services that match lenders with borrowers.

In an updated notification in February 2018, the RBI defined the P2P platform as an intermediary that provided the services of loan facilitation via online medium or otherwise. 

Basically, P2P platforms, look for borrowers – both individuals and businesses whose loan requirements and profiles match the business philosophy of the lenders listed with them. Then, the two parties connect via the platform. 

As stated, the P2P model works differently from a bank or credit union, which uses some of their assets, i.e. deposits from other customers, to fund a loan. With P2P, borrowers are matched directly with investors through the lending platform.

The P2P platform prepares the loan agreement document for the lender and the borrower. The borrower submits undated cheques as security, but as with any loan, the risk remains. Hence, it is up to the lender to check the borrower’s credentials.

Lenders charge fees on borrowers and take a percentage of the interest earned on loan. It is here that the P2P lending platforms want the RBI to ease up, and allow the entry of HNIs capable of lending up to Rs 1 crore. Currently, the lending ceiling is capped at Rs 10 lakh.

Related: How has India fared in terms of the economy since Independence? 

Different Social Lending

Given the involvement of individuals as lenders, P2P lending is also called person-to-person lending or social lending. Because of this, it is frequently believed to be another form of or even another name for crowdfunding.

This, however, is not the case. Yes, like peer-to-peer lending, crowdfunding too involves individuals acting as lenders, but this is where the similarity ends.

The principal difference is in the expectations of lenders. In crowdfunding, many people join hands to extend financial support for a dream project envisaged by someone or a group without expecting anything in return.

Lenders (actually donors) do not expect any monetary gain because their funding is not really an investment in the true sense. There is no interest piling up or no profit plough-back. Funds have been offered as a financial leg-up because the lenders believe in the project and want it to succeed.

However, with P2P, it is strictly business for the lender. Borrowers come to the P2P platforms to get in touch with investors (lenders) for unsecured personal loans. Lenders too look for suitable borrowers with the intention of earning a higher return on their investments.

Plus, lender-investors usually diversify their investments by lending to multiple borrowers in small amounts, all with the aim of increasing returns. Borrowing is in the form of personal loans. This would be for a variety of purposes that include debt consolidation and home improvement, making them vastly different from crowdfunding purposes.

Also, when the investors are companies, they are called P2P lenders or marketplace lenders. Some of these lenders are only open to institutional investors (hedge funds, commercial banks, pension or endowment funds and life insurance companies).

Edge over Banks

When compared to banks, P2P lending can flaunt a clear advantage in terms of ease and speed of processing. Loan approval and disbursement are fast compared to applying for a personal loan at a bank or an NBFC.

Credit requirements are usually less stringent than that of a bank, while the lending and borrowing transaction process is based on mutual understanding between borrowers and lenders. As a result, the P2P system is free of the typical, long-drawn documentation process. 

This, in turn, speeds up the transaction process. Also, there are minimal documents required. All that the borrower has to do is upload his or her personal details such as background, employment status, and credit history. Once this is done, they close arrangements online with lenders listed on the platform.

Many salaried and self-employed individuals with idle cash lying around have shown a willingness to act as lenders. Here, they can earn good returns as compared to earnings from mutual funds, equities etc. However, the risks are higher.

The ease of doing business in the P2P lending system is best reflected in the lenders’ approach to CIBIL scores and monthly income; they are less fussy in this aspect. 

By contrast, traditional financial institutions and banks are averse to extending loans to borrowers with poor CIBIL scores and below satisfactory monthly incomes. 

Moreover, in the P2P lending sector, borrowers can negotiate directly with lenders. Lenders diversify investments through multiple small-loan borrowers, the latter approach multiple lenders to extract low-interest rates and flexible terms.

As a result, P2P borrowers can successfully access personal loans at rates better than those offered by the banks. Those with low CIBIL scores and incomes are no exceptions to this. 

Related: Deposits in Jan Dhan accounts cross Rs 1 lakh crore 

Loan Slabs & Rates

But it is not as if the P2P system is tilted to benefit the borrower more with low-interest rates and flexibility towards their repayment records. It offers benefits to investors as well by helping them to earn sizeable interest on their loans.

The P2P platforms do not fix interest rates. It is agreed upon by the lender and the borrower. The platforms also do not take the money but they do facilitate collection of post-dated cheques from the borrower in the name of the lender as a proxy for repayment of the loan. They also help in loan recovery and follow up with borrowers for repayments, if need be. 

The online platforms where the entire process is conducted require both lenders and the borrowers to register themselves and connect with each other. The platforms also post their interest slabs as per loan amounts. This way, both sets of participants can decide how much they want to invest or borrow.

Some of the better known P2P sites and platforms licensed by RBI are Lendbox, i2ifunding, Faircent, i-lend and OMLP2P, apart from a host of smaller ones. Let us see the rates offered:

• Lendbox: On a loan of Rs 25,000 to Rs 5 lakh, its interest charge is 11.49% onwards for a tenure of 6-36 months. Apart from this, participants have to pay a registration fee of Rs 500.
• i2ifunding: Its rates start from 12% for a tenure of 1-36 months and registration fee of Rs 118 (Rs.100 plus 18% GST).
• Faircent: This platform has the lowest starting rate at 9.99% for amounts between Rs 10,000 to Rs 5 lakh, with a Rs 500 registration fee.
• i-lend: The second lowest starting rate among the five at 10.99% for loans of Rs 25,000 to Rs 10 lakh for tenures of three months and 36 months, while the registration fee is Rs 500.
• OMLP2P: It charges no registration fee, but has the highest starting rate at 15% for loans of Rs 25,000 to Rs 5 lakh for tenures of 6 to 36 months.

The platforms charge processing fees ranging from 2% to 10%.

Related: How RBI rate cut will impact borrowers and investors?

Sabka Saath, Sabka Vikas

The P2P lending system can be critical in shaping Prime Minister Narendra Modi’s slogan - Sabka Saath, Sabka Vikas – development for all, together.

Not only does the system encourage a sense of community good, but it also leads to wealth creation among small lenders as well as financially excluded borrowers.

The system also helps individuals who lack access to traditional banking systems but want to start an enterprise. In the process, idle funds are being brought into the system, creating funds for development.

Plus, it reaches the unbanked population directly and nullifies the importance of banks and other financial intermediaries for this segment. This is important, as according to a joint Assocham-ET study, more than 19% of India’s population is unbanked – a section that the P2P players offer loans to.

This is in addition to the credit it extends to individuals who may not be unbanked, but who cannot avail of loans through financial organisations because of their profile or those with low CIBIL score. Thus, it attracts and embraces people who have no other alternative to getting loans, and also helps them enjoy cost advantages over banks.

Finally, P2P lending helps both borrowers and lenders financially. On the one hand, borrowers can get better rates by successfully negotiating with multiple lenders. On the other, lender-investors earn higher returns from riskier loans compared to earnings from bank accounts.

So overall, it is Sabka Saath, Sabka Vikas.

Have a look at these 7 Government schemes to aid economic development and financial stability that you can benefit from, to gain more knowledge about how the government is aiding the country's development.