P2P lending promises high yields in a low-interest-rate environment. But credit risk is a problem.
Interest rates on bank deposits are at a decade low, and those on small savings schemes are close to a 40-year low. This has forced people to look for alternatives, one of which is peer-to-peer, or P2P, lending. Globally, P2P lending has been around for a decade, starting around the 2008 financial crisis. However, in India, it started four-five years ago, but without guidelines or recognition from regulators, which limited its popularity. However, last year, the Reserve Bank of India, or RBI, came out with regulations on P2P lending. Since then, it seems to have picked up pace.
First, let us understand what is P2P lending. As the name suggests, it is lending of money by one person to another with the helo of a collaborator, which is a fintech company. It works under a crowdfunding model where people who want to invest deal with borrowers directly on P2P online platforms created by fintech companies. The government recently gave these P2P players the status of non-banking finance companies, or NBFCs, to act as facilitators or intermediaries. They cannot lend money or take deposits or provide credit guarantee.
How It Works
Both borrowers and lenders have to register on the online platform. Those who want to invest register as lenders/investors while those who want a loan register as borrowers.
Registering as a lender: Those looking to invest can register by filling up an online form after submitting know-your-customer documents along with bank account statement. Each platform has its own criteria for this. For example, on i21Funding.com, only a person with annual income above `3 lakh can become a lender. A person can start investing with `5,000 at i2ifunding while at Faircent the minimum investment is `10,000. At Faircent, the minimum age for lenders is 18 years, while at i2i funding, it is 21 years. On registration, the amount the person wants to lend has to be transferred to an escrow account managed by a bank trustee. The money is directly transferred to bank accounts of borrowers chosen by the lender from this account.
Registering as a borrower: The first step is credit assessment for which every platform has its own criteria. Data related to educational qualification, employment, social media behaviour, credit score, age, income, location, etc, is gathered. P2P platforms also do physical verification of the office and the residential address. Every P2P lending platform has its algorithm based on which it does the borrowers credit assessment after analysing these data points. The borrowers are then classified into different risk categories ranging from minimum to very high risk. Loan amount, tenure and interest rate are decided on the basis of the borrowers risk profile.
Fees and Charges
For lenders: There are fees for different services such as registration and loan account statement. The transaction fee is 1-2 per cent of the loan amount. It is deducted from the first EMI. Some platforms do not charge for registration.
For borrowers: P2P platforms charge a processing fee of 2-8 per cent depending on the borrowers risk profile. This is debited from the loan amount before it is disbursed. A late payment fee is also charged in case of a delay in EMI payment.
Fund transfer: A loan agreement is signed between the borrower and the lender. The former has to provide post-dated cheques. RBI guidelines say fund transfer has to happen through the escrow account, operated by a trustee promoted by the bank maintaining the account. Every P2P platform has to open two escrow accounts, one for funds from lenders and pending disbursal and the other for collections from borrowers. All fund transfers have to be through bank accounts and cash transactions are strictly prohibited.
Interest rate: The rate will depend on the risk profile of the borrower and range from 12 per cent to 36 per cent depending on the platform you are choosing. For lenders, the rate of interest/return will depend on how their borrowers are spread acrossrisk categories.
Default: P2P lending platforms provide legal assistance in case of a default. However, the fee for sending legal notices or hiring recovery agencies have to be borne by the lender.
Taxation: The income earned by way of interest is added to the total income and taxed as per the slab.
Why Opt For P2P
Borrowers gain: When banks and NBFCs are readily willing to give loans, why would one go to P2P lending platforms where the rate of interest is generally higher?
Experts say P2P makes sense for those who are finding it difficult to get a loan from banks and NBFCs as they do not have a desirable credit score. "Borrowers who are not meeting the strict norms set by banks and those with no credit history can expect their loan proposals to be accepted by P2P lenders. Other advantages include simple online process for application and repayment of loans," says Rajeev Mahajan, Co-founder, Director and CEO of Antworks Money, a P2P lending platform.
The rate of interest is lower than what a money lender will charge. "Even borrowers who are rejected by banks due to low CIBIL score stand a good chance to get personal loan from us as we go beyond CIBIL score for credit evaluation," says Raghavendra Singh, CEO, i2i Funding.com.
What's in it for lenders: P2P lending can be used to diversify the portfolio provided the lender is aware of the risks. "For an investor, P2P platforms provide an opportunity to earn higher yields than traditional debt, and as long as the investor is capable of assessing the risk profile of the borrower, this could provide a good opportunity for investment and access to customers of the platform," says Kalpesh Mehta, Partner at Deloitte India.
Lenders have the liberty to decide whom to lend and the amount to lend after checking the profiles of the various borrowers on the platform. "An important benefit of P2P lending is that it gives lenders the autonomy to take decisions on their investments. With the help of transparent data, freely available on the platform, lenders can take informed decisions with respect to building their portfolio. The more diverse the portfolio, the lower the risk. Investors can mitigate risk by investing smaller amounts over large number of loans and choosing borrowers with varied risk buckets, backgrounds and purpose," says Rajat Gandhi, Founder and CEO, Faircent.com.
"P2P platforms provide complete analysis of the borrower's credit profile, which helps the lender understand the risk involved and take an informed decision," says Singh of i2ifunding.com.
Mehta of Deloitte cautions that the lenders must understand the risks before investing. "Since most borrowers on these platforms have limited access to traditional banking channels or poor credit history, credit risk is involved. Further, the investor has to rely on credit underwriting and 'decisioning' platform of the P2P player for a view on the credit profile/risk rating of the borrower," he says. The investor has to take an informed view of risk-adjusted returns as the interest rate offered on most P2P loans would be higher than what he would get on typical debt investments.
P2P platforms provide an attractive investment option but globally they have been struggling with fraud and defaults risks. RBI guidelines try to mitigate the risk to a certain extent but credit risk is still there. Investors can invest through P2P platforms to diversify their portfolio but after properly understanding the risks involved.