Peer-to-peer or P2P2 lending has been gaining traction among people following the news of fintech firms such as Cred and BharatPe venturing into the P2P segment.
P2P lending is not immune to risks, but it facilitates higher returns to lenders and lowers the interest rates for the borrower, making it favourable for both. It is a marketplace where both buyers and sellers meet.
To explore more, let us delve in!
What is P2P lending?
P2P is an online platform that provides lenders and borrowers flexibility, and a variety of lending and borrowing options. The P2P model brings together lenders and borrowers, making it easier to connect lenders and borrowers.
Borrowers can get funds at a cheaper interest rate than banks, while lenders can earn higher interest than bank deposits.
P2P Business Model
The P2P lending model is somewhat similar to crowd-funding. But the key difference is that in P2P lending you have to pay off the loan, while a crowdfunding fund is not required to pay it back.
During covid-19 times, we saw many small organizations were listing on online crowding platforms to collect money to help needy people. They are not obliged to return the funds to the public who donated. On the other hand, Peer-to-peer lending is an apparatus that connects individuals who need loans with individuals willing to lend.
It acts as an intermediary or channel between the lender and borrowers and facilitates the process to book a spread. An individual or a company can register as a borrower or lender on P2P platforms after furnishing the necessary documents.
Earlier P2P lending companies were not recognized as NBFCs but in 2017, in late September, RBI came up with “Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017”, in which the central banking institution laid down a list of directions relating to the registration and operation of NBFC-P2Ps.
According to the RBI guidelines, ‘Peer to Peer Lending Platform means an intermediary providing the services of loan facilitation via online medium or otherwise, to the participants.’
“The Reserve Bank of India, on being satisfied that it is necessary to do so, in the exercise of the powers conferred on it by… the Reserve Bank of India Act 1934, (2 of 1934) with prior approval from the government, hereby specifies, a non-banking institution that carries on the business of a peer-to-peer lending platform to be a non-banking financial company,” the notification sent by RBI to the government stated (back in 2017).
“P2P lending promotes alternative forms of finance, where formal finance is unable to reach and also has the potential to soften the lending rates as a result of lower operational costs and enhanced competition with the traditional lending channels. If properly regulated, P2P lending platforms can do this more effectively,” the apex bank stated in the paper.
Unlike traditional banking and financial institutions, the P2P model is a next-gen credit model to meet current business credit needs. Faircent, Paisadukaan, Finzy, Rupeecircle are some of the P2P lending platforms. The latest development in the sector is the entrance of BharatPe and Cred.
Also Read: List of top 10 P2P lending startups in India
Individuals, high net worth individuals (HNIs), Hindu Undivided Families (HUFs), and other non-banking entities can use P2P lending to pool their savings.
An auction is held under the P2P business model, in which a lender can submit a bid for a borrower’s loan needs, which the borrower can accept or reject. In addition, the platform can provide services such as recovering loans, and so on.
The rate of interest ranges from 10% to 28% and it has to be repaid in 3 months to 36 months. In the case of Cred, those investing in this platform will earn interest of around 9%, while it will be paid out at 12-13% interest.
Once the borrower and the lender reach an agreement, they sign a legally binding contract digitally. After that, the agreed loan amount is transferred to the borrower’s account that s/he has to repay periodically in a stipulated time just like EMIs. If the borrower defaults at repaying EMI within a specified time, a penalty is imposed on the borrower which is directly payable to the lender.
Deciding Factors Before Giving Loans
In the traditional lending system, a credit score determines the creditworthiness of a borrower. In the case of P2P platforms, they have their parameters to check the creditworthiness of borrowers.
Some of the parameters include employment, income, credit history is fetched using technology, the borrowers’ habits are traced via tracking social media activity, app usage, and so on.
Such details determine a borrower’s capability to repay the loan and in which period, in short, creditworthiness and then, these platforms put them under different risk buckets.
Are P2P Lending platforms Safe To Invest In?
P2P platforms are generally used by those individuals who fail to avail loans from traditional lenders such as banks, stating they do not meet the bank’s prerequisites. Therefore, a significant risk is involved in lending to these borrowers as such loans are unsecured.
In case, the borrower defaults at payment, P2P platforms do not assure of full repayment of principal or interest thereof.
But, as per the leading publication, in case of default, such platforms assist in recovery and filing legal notice, but do not guarantee its success.
It should be noted that as per the rules prescribed by RBI, no P2P platform can hold the funds invested by the lender or paid back by the borrower. Such funds are to be kept in the custody of a third party until the specified condition has been fulfilled.
Peer-To-Peer Lending Indian Market Overview:
IndustryARC report says that India P2P lending Market size will reach $10.5 billion by 2026, after growing at a CAGR of 21.6% during the estimated period 2021-2026.
The Indian Government’s push to cashless technologies has been a major attribution to the restructuring of the financial sector, breaking the monopoly of traditional institutions like banks.
Online P2P lending is estimated to hold a majority stake in the P2P lending market with a 97% share in 2020. The report said, “The digital operations for P2P lending platforms ensure that the overhead costs required for maintaining and staffing a physical establishment are circumvented. This benefit can be passed onto the borrower in the form of lower interest rates and processing charges. Additionally, the online lending platforms ensure relatively faster loan processing than the traditional loan platforms due to minimal paperwork involved.”
According to the Cambridge Centre for Alternative Finance, the Fintech Credit has grown to $364 billion in 2019 compared to $11 billion in 2013 globally.
The real estate application is also seen to grow at a CAGR of 25.7% during the forecast period 2021-2026. The real estate industry finds Peer-to-Peer lending as the second-best alternative to traditional financial institutions.