Peer to Peer or P2P loan is a process by which an individual lends money or grants a loan to another individual through an intermediary. The intermediary is usually an online or digital platform, the main function of which is to find and match borrowers and lenders.
It is a simple business model in which a person with available money (lender) invests the money by giving a loan to someone who needs it (borrower). The lender earns money from the interest earned on the loan. Interest rates tend to be high because borrowers are usually the ones who are unable to borrow cheaply from banks and other loan companies. The intermediary or platform will generally receive a commission for the lender-borrower matching services it provides.
The P2P loan model was created in 2005 with Zopa in the UK. Funding Circle in the UK and Lending Club in the US are the most popular companies operating under this model.
P2P loans were growing in popularity, and in 2016 there were around 30 such platforms. After the RBI intervened in late 2017 and subsequent regulatory requirements, the number fell to less than 15. Faircent, i2i Lending and LenDenClub are some examples of popular platforms in India.
While the business model is simple, it comes with some very unique challenges. First, the lender is unable to assess the risks associated with the borrower, including any misrepresentation of information. Second, the middleman does not have the skin for the game and takes no responsibility for the results. Third, the platform must attract both borrowers and lenders, thereby doubling the marketing activity. The adoption of the business model in its worst form has been seen in China where several P2P platforms have committed serious frauds, losing billions to small investors. In many cases, there were false borrower profiles and complete misrepresentation of information. P2P operators have embezzled funds by not transferring them to borrowers. Such practices did away with what was an innovative way to invest and borrow money.
P2P loans can be made sustainable through effective regulation. Credit goes to the Reserve Bank of India for intervening in this segment in 2017 and introducing strict rules. The RBI is among the first regulators in the world to introduce supervision and regulation in the P2P segment. As part of the regulations, a new category of non-bank financial corporations (NBFCs) has been defined, called NBFC-P2P. Like other NBFCs, a minimum of Rs 2 crore of net held fund is required to qualify. Other rules required these platforms not to lend themselves, not to use money from lenders or borrowers, not to cross unrelated products, to profile the risks of clients, to document loan agreements and provide collection and collection services. Additional prudential standards set a ceiling on the total exposure of an individual lender at Rs 10 lakh on all platforms, a ceiling on the total loans of a borrower on all platforms limited to Rs 10 lakh, a maximum duration 36 month loan and exposure from a lender to a borrower not to exceed Rs 50,000.
The RBI did the right thing by introducing regulations for this segment at a very early stage in the industry’s development. There are a number of additional steps that can be taken to make this industry commercially scalable and sustainable. Some of them are detailed below.
Default guarantee on loans is a standard technique for most fintech lending players, in which fintech platforms underwrite and process loan applications on behalf of lenders (banks and NBFC). In order to build confidence in their underwriting and processing, fintech platforms offer a default guarantee (often referred to as a first-loss default guarantee or FLDG), which means that the first “X”% of the loss, the where applicable, will be covered by the fintech platform. . This establishes a clear in-game skin for the platform. Likewise, P2P platform lenders should be able to take these guarantees from the platform in exchange for sharing a portion of their income to be passed on as a reward to the platform for sharing the risk.
The co-loan is another way to share the risk between the platform and the lender. In this, the platform would lend a certain proportion for each loan via its balance sheet. Although RBI rules prohibit lending to P2P platforms, the introduction of co-lending will create much better risk protection for lenders, as the platform will have to share the risk and reward of each loan. .
Disclosure and transparency rules need to be further improved and require P2P platforms to clearly indicate their risk assessment and mitigation methodology. The underwriting criteria, the information used and the models applied must all be made transparent to the lender as well as a regular update of the performance of the portfolio.
Taking inspiration from the Financial Conduct Authority (FCA), the UK regulator, a suitability test should be introduced for the lender. This test will work much like the risk profiling performed by banks before making mutual fund recommendations. Here, a client’s knowledge and experience will be tested before they make any investments. Moreover, to add, the cap of Rs 10 lakh can be removed and instead the relevance test result should be used to determine the degree of exposure that an individual may have in P2P loans. A sufficiently knowledgeable and wealthy person should be able to invest larger amounts. It will also create a way to further develop the P2P industry while protecting the interests of the lender.
Sameer Aggarwal is the Founder and CEO of RevFin.