The Government of India and RBI have taken significant steps in the last few years to achieve financial inclusion. The Jan Dhan Yojana, the Digital India initiative, launch of payments banks and small finance banks have contributed in improving the reach of formal financial services to hitherto unbanked population and areas. However, there is still a long way to go when it comes to access to credit from formal channels. The share of unorganized lending in India remains notoriously high.
The latest CRISIL Inclusix report (covering readings for fiscal 2016) states that a large part of the country’s population does not have access to credit services from banks or microfinance institutions. Only 20 crore borrowers have loans from institutions, which is significantly lower than the number of deposit accounts.
What is P2P lending?
Peer-to-peer (P2P) lending refers to lending of money by one person to another, with an online platform acting as a collaborator. People who want to lend (invest) deal with borrowers directly on online platforms created by fintech companies. The RBI recently gave P2P platforms the status of Non-banking Finance Companies (NBFCs) to act as intermediaries.
Some of the well known P2P platforms in India are Faircent, LenDenClub, i2iFunding, I-Lend, Lendbox.
How P2P lending works
- People who wish to lend are required to register on the online platform
- The platform generally asks for certain documentation for KYC compliance along with bank statements
- Different platforms have devised their own eligibility criteria for lenders. The restrictions are generally in the form of minimum age, minimum annual income, minimum investment required
- Post registration formalities, the lender is required to transfer the amount he/she wishes to lend to an escrow account (An escrow account is a temporary pass through account held by a third party during the process of a transaction between two parties)
- Loan listings are visible on the lender’s dashboard along with relevant financial, credit and personal details of each borrower. Lenders can use this information to make an informed choice and send a proposal to fund the selected borrower(s)
- People who wish to borrow are required to register on the online platform
- Based on KYC and other documentation, the P2P platform does an identity-verification, credit check and risk assessment of the borrower – this system is generally automated through the use of computer algorithms. Some platforms also do a physical verification of the office and residential address
- Based on the credit and risk assessment algorithm, the borrower is assigned a risk category (for example – low, medium and high). This categorization is used in determining the loan tenure, interest rate and the maximum loan amount. Interest rates generally vary between 12% – 36% per annum
- Once the loan is listed on the platform, multiple lenders can view the listing and send proposals to fund it at the given interest rate
Fund transfer and repayment
- Once the lender and borrower have reached a mutual agreement, the P2P platform facilitates the signing of a legally-binding agreement between the two
- Often, the P2P platforms follow a paperless process wherein the agreement is signed online using digital signatures
- The 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 are required to be made through these bank accounts and cash transactions are prohibited
- Most P2P platforms also provide legal assistance in case of default. However, the fees for recovery have to be paid by the lender
Fees charged by P2P platform
Lenders are required to pay fees for registration formalities and services like loan account statements (Some platforms may not charge a registration fee). Platforms charge 1 – 2% of the loan amount as transaction fee – general practice is to deduct this fee from the first EMI paid by the borrower
Borrowers are also required to pay registration fees on most platforms. Processing fee in case of borrowers ranges from 2% – 8% (primarily dependent on borrower’s risk profile). This fee is debited from the loan amount and the net amount is disbursed to the borrower. Late payment fees are also charged.
Benefits of P2P lending
P2P platforms are beneficial for borrowers with low credit score or no credit history – in such cases, it is difficult to get loans from banks and NBFCs. P2P platforms consider a lot of parameters besides credit score to judge credit worthiness of borrowers. Also, the process of obtaining loans through these platforms is quite simple and online.
For lenders, P2P platforms provide an opportunity to diversify their portfolio and earn better yields than traditional debt instruments. The platform facilitates risk profiling of borrowers, helping lenders take informed decisions.
While P2P lending is a fast growing sector – there are certainly fraud and default risks involved. RBI regulations have capped the risks of P2P participants. For example, the aggregate exposure of a lender as well the total loans taken by a borrower across P2P platforms should not cross INR 10 lakhs. Moreover, the exposure of a single lender to the same borrower, across all P2Ps, shall not exceed INR 50,000.
As per a report by CARE ratings (November 2017), there are more than 50 P2P lending platforms in India and the outstanding loans across platforms is estimated to have reached INR 50-60 crores. With increasing digitization, customer education initiatives and increased acceptance because of coming under RBI’s purview, P2P lending is expected to show robust growth over the coming years.
Author | Arpit Lahoty