Peer-To-Peer Lending: Credit Fairytale Or Regulatory Nightmare?

The Indian investment landscape is evolving rapidly, owing to increasing digitisation, growing financial aspirations and emerging market instruments. One of these instruments is peer-to-peer lending, also known as P2P lending. The concept of this instrument is traditional but platforms and norms for the same are evolving. Let us dive deep into the space of P2P lending, understand how it works, look at P2P regulations in India and evaluate its advantages and disadvantages.

The Credit Innovation: Peer-To-Peer Lending

Before the establishment of financial institutions, lending of money from one individual to another was done informally. However, it is capable of causing great perils to both parties due to the absence of any formal regulations or agreement.

A modernised version similar to such a lending process is peer-to-peer lending. It allows an individual or business to lend money without the requirement of any intermediary institution. Therefore, P2P can be used as a debt-financing model to eliminate a direct intermediary in the lending process.

Credit is an inseparable part of business, and such a financing model can be a beneficial instrument. The indirect intermediary in this process provides a platform for potential borrowers and lenders for P2P finance. Understanding the workings of these models can help one evaluate it as a credit option.

How Does P2P Lending Work?

The lending model involves three parties - lender, borrower and P2P platforms. The process of P2P lending is carried out as follows:

1. A borrower seeking credit will apply for a loan on a lending platform. Lenders also create their profiles on these platforms.
2. The overall profile, such as risks and repayment capacities, will be assessed by the P2P lending platform.
3. Following this, the probable interest rates based on lenders, borrowers and their profiles are decided by the platform. 
4. When lenders select a borrower, the loan is approved, and the lending process begins.
5. A single loan can be facilitated by multiple lenders. 
6. Finally, the borrower repays the loan and interest as per the instalment process. Then, the platform distributes the returns to the lender of that particular credit.

Advantages And Disadvantages Of P2P Lending Platform

Exploring both the advantages and disadvantages of P2P lending can help investors evaluate the option for investment or credit. 

Some advantages of P2P lending are as follows:

• The instrument is one of the alternatives to regular debt-financing instruments such as unsecured loans.
• Prospective borrowers only need to register and apply for a loan on the P2P lending platforms. It eliminates the regular cumbersome paperwork procedures.
• Lenders can diversify their investment options with these platforms, and may earn potential competitive returns.
• One loan can have a diverse set of lenders. Therefore, the potential risk can be diversified.
• Due to the availability of diverse lenders and almost zero paperwork, the loan can be disbursed quickly compared to regular lending options.

However, like every coin has two sides, P2P lending also has some disadvantages:

• The unavailability of a central institution may give rise to trust issues between the lending and borrowing parties.
• Some borrowers, devoid of regular loan facilities due to their lack of repayment capacity, explore the P2P lending option. It can potentially cause credit risk.
• P2P lending is comparatively a young industry in India. Therefore, the regulation horizons are gradually becoming stringent to safeguard the parties involved.
• In modern times, P2P lending is heavily digital. The unavailability of suitable technology for processing P2P finance may create a hindrance.

P2P Regulations In India

The landscape of P2P lending has been evolving in recent years. The Reserve Bank of India (RBI) regulates these lending platforms in India. The space of NBFC-P2P lending (as known in India) is regulated by master direction for NBFC-P2P (Reserve Bank) directions, 2017¹. RBI mandates certain regulations for companies seeking to operate NBFC-P2P platforms:

• The entities registered under the Companies Act, 2013, with Certification of Registration (CoR), can seek registration as NBFC-P2P. Moreover, their net owned fund should be a minimum of INR 2 crores. This registration is also mandatory for the existing NBFC-P2Ps.
• The NBFC-P2P are categorised in the base layer of the NBFC regulatory structure.
• These platforms will be the only intermediary between the lender and borrowers.
• The limit for individual lenders is INR 50 lakhs across all the P2P lending platforms. 
• If a lender is investing more than INR 10 lakhs (across all P2P platforms), then the individual needs to furnish a net worth certificate from a practising chartered accountant. It would certify that the net worth of this lending individual has a minimum net worth of INR 50 lakhs.
• The limit for borrowers is INR 10 lakhs across all the P2P lending platforms.

List Of P2P Platforms In India

As of August 2024, there are 26 NBFC-P2P lending platforms in India. Some of these platforms are as follows:

1. LenDenClub
2. Lendbox
3. FairCent
4. MobiKwik Xtra
5. Finzy

Future Of P2P Lending

India is home to 144 crore people, and such a large population creates a huge market for new and innovative credit instruments. Moreover, innovation in financial products goes hand in hand with constant technological upgradation. A report suggests that the P2P lending space may grow by 21.6% Compounded Annual Growth Rate (CAGR) from 2021-26².

Some key reasons like growing demand from small and medium enterprises for credit and requirements for consumer credit may drive the potential growth. However, this growth can be hindered by some challenges, such as:

• The stringent regulations by RBI are stirring fear among the P2P lending platform owners. Recent regulations regarding the limits for lenders and borrowers can potentially affect the industry.
• Several big companies are looking to enter the space, which may increase the competition.

The future of P2P lending is potentially bright, but investors can explore alternatives for P2P lending. It can potentially help to diversify their portfolio.

Alternatives To P2P Lending

Apart from peer-to-peer lending, investors can seek options like securitised debt instruments (SDI). These instruments offer investors a modernised debt instrument. One of them is LoanX. It’s a secure and SEBI-regulated investment option listed on the stock exchanges (NSE/BSE), where you can expect around 12-14% returns. 

Are you looking to invest in a securitised debt instrument (SDI)? Login to Grip and explore more!

Conclusion

Peer-to-peer lending is a unique debt instrument. It provides an opportunity to avail quick credit without hefty paperwork. The industry is quite young in India and is evolving with various attributes. Striking a balance between the advantages and disadvantages of P2P lending can help investors evaluate it as an option. Moreover, investors can also explore alternatives to this instrument.

Frequently Asked Questions On Peer-To-Peer Lending

1. Is P2P lending high risk?

P2P lending connects lenders and borrowers over a platform that can help access credit. It has several advantages such as easy paperwork, quick process, diversification for lenders, etc. However, certain risks are attached to this instrument, such as the default risk of borrowers and the lack of a central intermediary. Closely accessing the pros and cons can help one make the best use of this instrument.

2. Are there secured alternatives available to P2P lending?

Rather than unsecured debt-financing options like P2P lending, investors can explore LoanX by Grip. It is Securitised Debt Instrument (SDI), that puts money in the pool of loans from trusted financial institutions. It is a secured instrument as LoanX opportunities are rated by leading credit rating agencies such as CRISIL and ICRA. It is listed on the stock exchange and manageable in a demat account.

3. What are secured and unsecured loans?

Loans backed by reliable mortgages are known as secured loans, while unsecured loans are not accompanied by any mortgage. The mortgages can be in the form of real estate property, vehicles, financial instruments, etc. and they can be kept as collateral.

4. What are the benefits of investing in secured loans?

Investing in secured loans can provide investors peace of mind that their funds are safe. The backed collateral is evaluated while giving secured loans. Moreover, it can provide investors with a diversification option.

5. Is P2P lending legal in India?

Yes, peer-to-peer lending is legal in India and is regulated by the RBI. It is regulated by master direction for NBFC-P2P (Reserve Bank) directions, 2017.

References

1. RBI, Accessed from https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11137. 
2. Industry Acr, Accessed from https://www.industryarc.com/Report/19467/india-p2p-lending-market.html. 

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