With RBI As Regulator, P2P Lending Platforms May Gain Popularity

Many of you might have desisted from borrowing money through peer-to-peer (P2P) lending platform, as these are largely unregulated mediums. This may change soon. According to media reports, the Reserve Bank of India (RBI) is expecting the government would soon provide it with the mandate to regulate these platforms, a move that will open a new avenue for those seeking monetary assistance.

Also read: Points In RBI's Annual Report That Homebuyers Should Take Note Of

Conceding that "the potential benefits that P2P lending promises to various stakeholders and its associated risks to the financial system are too important to be ignored" despite it being "nascent in India and not significant in value yet", the central bank had released a consultation paper on P2P lending in April last year.

Let us try to understand how P2P lending works and where does it stand today as far as India is concerned.

What is P2P lending?

So many of us are in the dire need of money, especially homebuyers, and do not have the time and patience to deal with the lengthy and complicated process one has to follow to avail of facilities offered by financial institutions. Similarly, many of us have with us a certain amount of saving lying without yielding anything. We would like to make better money using these funds, but do not know what to do. Peer-to-peer lending is the way for both these set of people. Using online channels, one set can meet another and agree to do business on terms and conditions that satisfy both the parties. P2P lending, as the RBI consultation puts, is a form of crowd-funding in which online platforms match lenders with borrowers in order to provide unsecured loans. 

P2P lending would work as an alternative source of financing for those homebuyers who are not able to avail of bank finance due to a low credit score. Those who have to arrange the funds quickly to materialise their house purchases will also find the prospect quite benefitting. While it is easier for salaried individuals to secure a loan from banks, professionals who run their own small-business may find it difficult to get a loan. After they come under the purview of the RBI, P2P platforms will greatly benefit such professional, too. Apart from that, if a borrower is able to find a lender who is willing to offer loan at a cheaper interest rate, the overall cost of the purchase can come down substantially.

It is worth mentioning here that crowdfunding falls under the purview of the Securities and Exchange Board of India while P2P lending would be monitored by the RBI.

How does the platform function?

Typically, P2P companies follow a reverse auction model. Here, lenders bid for a borrower's loan proposal. A borrower has the freedom to accept or reject the offer. After a proposal has been accepted, the lender transfers money from their bank account to borrower's bank account. The platform facilitates the collection of post-dated cheques from the borrower in the name of the lender as a proxy for repayment of the loan. The documentation is also facilitated by them. The P2P forum also helps in the recovery process. It also employs recovery agents.

Mode of payment

Apart from paying the interest on your loan amount, you also have to pay banks a processing fee and several other small charges. Similarly, you also have to pay P2P platform for using their services to borrow or lend money.

Depending on their risk category, borrowers pay an origination fee. This could either be a flat charge or a percentage of the loan amount.  P2P platforms do a preliminary assessment of borrowers' creditworthiness and provide them with a credit score.

Lenders, on the other hand, have to pay an administration fee, apart from additional charges in case they choose to use any other services offered by the platform.

Now, what about interest rates? How are they set? Are rates lower than what is offered by leading financial institutions? Well, it depends. At P2P platforms, the interest rate may be set by the platform itself or by mutual agreement between the borrower and the lender. Interest rates and the methodology for calculating those rates vary among platforms.

However, P2P platforms are beneficial for both parties.

“One of the main advantages of P2P lending for borrowers has been lower rates than those offered by money lenders/unorganised sector and the advantages for lenders are higher returns than what conventional investment opportunities offer,” says the RBI consultation paper.

A noteworthy point here is that P2P lending platforms make a profit from arrangement fees. Banks, on the other hand, make profit using the spread between lending and deposit rates.

 AlsoYou may like to read: An Explainer: Interest Rate Spread

Who are you dealing with?

Now, arises the question, what is the guarantee that you are dealing with genuine players at P2P platform? Once the borrowers and lenders register themselves on the website, service providers carry out a background check. Only after getting a satisfactory response, a platform allows people to do business.

Where does P2P lending stand as of now?

Globally, lending through P2P platforms has grown from £2.2 million in 2012 to £4.4 billion in 2015. While data about the size in India is not available, there are about 30 P2P lending companies in India. About 20 new companies have been launched in the past one year. This number is expected to go bigger in future. A popular concept in countries such as France, Germany, Italy, the US and the UK, P2P lending is banned in Israel and Japan.

Also read: RBI Leaves Repo Rates Unchanged At 6.25%