P2P (or Peer to Peer) lending and borrowing is like a digital marketplace for loans. Instead of applying for a loan with a bank, or any other financial institution, you can initiate a request for a loan from individuals like you and me. This concept of P2P lending is centered around lenders getting higher interest rates by lending their money instead of putting it in savings and borrowers getting lower interest rates as opposed to getting a loan from a bank.
How does it work?
Traditionally, anyone who wanted to take a loan, individuals or businesses, had to apply for one through a bank. The bank in turn would run extensive financial background checks to determine the applicants’ credit score and loan history to determine if they qualified for a loan and, determine the interest rate that was charged on the loan.
P2P lending works best for early stage startups and entrepreneurs who need to kick-start their business.These businesses usually seek seed or venture funding to acquire the cash to get started. Maybe as an early stage startup you’re not ready or in need of that much money or you’re not ready to liquidate your equity. Getting a loan from a bank demands higher interest rate and collateral. This is where alternative modes of lending like P2P come to play. Entrepreneurs can borrow smaller amounts of money from individuals with ease.
With peer-to-peer lending, borrowers take loans from individual investors who are willing to lend their own money for an agreed interest rate. The profile of a borrower is usually displayed on a P2P lending platform, where investors can view borrowers’ profiles and decide if they want to lend money to them. A borrower might receive the full loan amount or only a portion of what he asked for from an investor. In the case of the latter, the remaining portion of the loan may be funded by one or more investors in the peer lending marketplace.
The good and the bad of P2P Lending
The process of P2P lending carries its own set of advantages and disadvantages.
For the borrowers
- Lower interest rates and lack of collateral required for a loan.
- Online and paperless application
- Fixed monthly payments
- Credit requirements may be less strict than at a bank
- No prepayment charges
- P2P lenders may be more inclined to invest in business ideas than banks would
- Lower loan amount as compared to a bank
- Missed payments will hurt your credit score
- Lower security than a bank
- No uniformity when it comes to requirements, changes from lender to lender
- Sometimes more borrowers than lenders
For the lenders
- Potentially, higher returns than savings and mutual funds
- Receive monthly payments with interest
- Diversify your risk across many different loans rather than making a single loan or investing only in stocks
- Risk of losing your money if borrowers default
- Less liquidity than stocks or bonds because of long time horizons (three to five years)
- Lesser protection or regulation to prevent fraud, delinquency.
Operational Model in India
One factor that has played a huge role in the rise of alternative lending industry in India, was the slowdown in lending by banks during 2016-17.Loans to businesses slowed down,forcing many businesses to seek other methods of financing.
P2P lending in India is set to grow into a $ 5 billion industry by 2023. The domain’s origin actually dates back to 2012, when the first peer-to-peer lending company i-Lend was launched. At present, the P2P lending space is populated by more than 30 players including Faircent, LendBox, LenDenClub, IndiaMoneyMart, Monexo, Rupaiya Exchange, LoanBaba, CapZest, i2iFunding and many more.
Alternative lending startups have already attracted $220.66 Mn in funding between 2015 and 2017,and this accounts for around 2.5% percentage of the overall fintech funding of $2 Bn during the said period, as per Inc42 Data Labs report.
To help these platforms’ growth in a structured, fair and regulated manner, the RBI has released guidelinesto regulate P2P lending platforms and help steer the country’s social lending market in the years to come. RBI has proposed giving Non Banking Financial Corporation (NBFC) status to peer to peer lending companies in India. It has also announced various other guidelines to safeguard the interest of all lenders, borrowers and P2P lending platforms. Experts also predict that P2P lending portals will be able to access credit data, which will result in more informed lending decisions on P2P platforms.
India Stack and P2P Lending
India’s Digital Stack, including Aadhar, eKYC and UPI is paving the way for the country’s shift to a cashless economy. India Stack simplifies the payment challenges which some with alternative lending methods like P2P. eKYC provides information to lenders/P2P lending platforms to better understand the borrower. Access to Aadhar information, further helps lenders verify their borrowers. UPI enables all bank account holders in India to send and receive money instantly from their smartphones without the need to enter bank account information or net banking user id. This helps in better facilitation of digital payments.
The fintech sector has seen immense support from recent government policies, towards the innovation and adoption of technology,while also urging traditional banks and financial institutions to up their game. Consumer demands are evolving, and emerging sectors like online P2P lending are best positioned to address them.
The current Indian P2P lending sector has promising players and businesses that will skyrocket the growth in this particular industry.
Documents required to apply for a P2P loan
P2P platforms leverage metrics such as credit scores and social media activity to link borrowers and lenders at favourable interest rates. Currently, these platforms have low regulatory restrictions as they simply act as a middle-man between lender, borrower and the partner bank.
The documentation required for lending and borrowing is facilitated by the P2P platform, the individual decides to use. The lender transfers money from his/her bank account to borrower’s bank account. This platform then facilitates the collected of post dated cheques from the borrower, in the lender’s name. This acts as a proxy for the repayments of the loan.
The regulatory concerns in such cases would relate to KYC and recovery practices. Since all payments are through bank accounts, the KYC exercise can be carried out by the banks concerned. Though these platforms claim to follow soft recovery practices, the possibility of use of coercive methods cannot be ruled out.
After the RBI’s regulation, if you need a P2P lending license, your P2P lending platform must be NBFC registration.