- Date : 18/01/2020
- Read: 7 mins
Is that fixed deposit offering you a very low-interest rate? Want to up the game a bit? Here’s the newest form of investment that promises great profits!
India recently overtook United Kingdom as the world’s 5th largest economy with the GDP clocking US$2.94 trillion in 2019. Almost 30% of that contribution comes from micro, small & medium enterprises (MSME).
With India ranking favourably as the best nation with respect to ease of doing business among all Southeast Asian countries, the Central Government’s initiatives such as ‘Make in India’, digitisation of banking and financial services, and the largest and youngest workforce available, are all helping MSMEs lead the charge for the future growth of India.
While MSMEs have no dearth of ideas and ambition, it is usually funding that is the problem. Financing can help streamline operations by eliminating gaps in the working capital requirement or the capital infusion required to take the business to the next level.
While banks and non-banking financial companies (NBFCs) are looking to tap the potential of this huge borrower’s market, private investors now have the opportunity to make lucrative returns via the new-age lending model called peer-to-peer platforms, or P2P.
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1. What is peer-to-peer lending?
As the name suggests, P2P lending is the practice of individuals (who are looking to invest) lending money to peers or small businesses via P2P platforms. This is done without the aid of official financial institutions such as banks and NBFCs.
This method of debt financing or crowdlending is conducted through an intermediary’s digital platform that brings investors and small businesses together for a financially beneficial partnership. Adequate due-diligence is done by the P2P intermediary, also known as a fintech company before any of the parties are allowed to participate formally.
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2. How does P2P work?
P2P works a little differently from a bank loan. While a bank uses its deposits (from other customers) to fund the loan, in a P2P scenario the debtor and creditor are matched directly through the fintech platform. P2P loans usually go out as small personal or business loans.
Through the intermediary’s online marketplace, the investor gets to see a list of intended borrowers. The profile of the borrower is vetted by the intermediary, based on complex (usually proprietary) algorithms that assess the creditworthiness of a proposed borrower over various risk factors. These include their personal profile, credit score, job/business stability, moral and social score (derived from social media interactions), questionnaires, and telephonic interviews.
An investor has the option of fulfilling partial or complete requirement of the borrower. Most fintech companies allow only a partial investment in a single requisition, so that the risk is spread out better.
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3. Who can invest in P2P?
As with any financial investment, you need to understand how the product works and if it fits your financial and risk profile. P2P lending is structured as a debt product but offers much higher yields compared to traditional debt instruments such as bank deposits on account of the risk of default associated with it.
While bank deposits may offer 7% to 9% on investments, yields on most P2P opportunities start from 12-14% going all the way up to 35%, where the yield is directly proportionate to the risk involved. Investments that offer a 12% return have a default rate of about 2%, while those offering 35% have a default risk of 9-10%.
Most fintech companies have a very low investment threshold, starting at Rs 750-1000, which is the best way to test the waters. This allows you to improve your skill to conduct due diligence and learn how to allocate funds.
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4. The P2P marketplace
The P2P model is still in a nascent stage. The crowd-lending model began to emerge in India around 2014, but was fairly unregulated till 2017. In October 2017, the RBI issued a set of guidelines and regulations for the P2P intermediaries. The Central Bank understands that even though the product is not yet mainstream, it can have tremendous financial implications if left unmonitored.
In a bid to safeguard lenders’ interests and bring standardisation into the system, the RBI has brought P2P platforms under its purview, while awarding the P2P platforms the status of NBFCs in 2018.
There are about 30 P2P fintech companies in India of which only eight have received a Certificate of Registration (CoR) from the RBI: Fairassets Technologies India, FincSquare Fintech, Bridge Fintech Solutions, Bigwin Infotech Pvt. Ltd, OHMY Technologies Pvt. Ltd, i2iFunding, Cashkumar, and LenDenClub.
A fintech company has to fulfil certain eligibility criteria before being awarded a CoR as an NBFC. The P2P agreement is a tripartite one between the borrower, the lender, and the P2P platform. As per RBI directives, all funds have to move via escrow accounts operated by a trustee appointed by the escrow bank. The intermediaries make their money on either or both ends of the lending and borrowing spectrum.
At the borrower’s end, they may charge an application fee, take a small percentage of the loan disbursed, and add charges on prepayment/default, etc. At the lender’s end, there might be an investing/reinvesting fee or withdrawal fee (from the escrow).
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5. How to register?
If you wish to lend money on P2P platforms, you will need to register with your email id and mobile number. You will be required to upload necessary documents such as PAN Card, Aadhaar Card, driving license, bank statements, etc.
After a mandatory verification process, the platform will approve your account if all documents are in place and you meet their standards. Once that is done, you can log in to your account and start lending.
To register as a borrower, you need to register on the desired P2P platform. You will have to fill an online form and pay a one-time registration fee. You will have to produce all supporting documents such as PAN Card, Aadhaar Card, driving license, salary slips, ITR returns etc. P2P platforms may also ask for your social media links such as LinkedIn and Facebook.
Your application will then vetted by a risk assessment team. Once qualified, your profile will be listed along with the required loan amount on the P2P platform for lenders to see.
6. Features and benefits of investing in P2P
P2P offers options for diversifying one’s investment portfolio outside the usual equity products and bank deposits.
With the inherent risk involved, P2P lending offers returns unmatched by any other debt product. One can create a diversified portfolio with varying degree of risk spread across investments.
The RBI has limited the exposure to Rs 10 lakh for total lending, with a limit of Rs 50,000 towards a single borrower, thereby limiting risk exposure.
There is no lock-in period for the investment. One can enter and exit an investment anytime, but RBI has mandated a maximum maturity period for any loan at 36 months.
To minimise risk, P2P platforms levy steep penalties and deploy recovery agents to keep default rates to a minimum. In case of a dispute or default, legal recourse is possible on account of a legally enforceable contract.
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Conclusion
P2P lending can offer MSMEs the capital infusion their business requires at a relatively quicker and possibly cheaper rate than traditional banks. It could turn out to be a great portfolio diversifier for investors. However, strong adherence to standards and monitoring of the same is required.
As an investor, it is important to assess the risk before being lured by overselling promises, which rival equity products. Stick with agencies that are tenured and accredited by the RBI.
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or legal advice. You should separately obtain independent advice when making decisions in these areas.
