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Peer to Peer (P2P) Lending in India

Narendra Kumar

| Updated: Nov 06, 2017 | Category: Peer to Peer Lending

P2P-Lending

P2P lending companies operate online with lower overhead in comparison to traditional financial institutions. In this post, we will discuss P2P Lending in India and Global scenario and process for how to get P2P Lending License.

What is Peer to Peer (P2p) Lending Business?

Peer-to-peer lending (P2P) platforms shall be treated as Non-Banking Financial Companies (NBFCs) and it shall be regulated by the Reserve Bank of India (RBI)[1]. A P2P lending platform provides a method of debt financing which helps individuals to borrow & lend money without taking help of any financial institution as an intermediary but it takes more time, effort and risk. P2P lending is mainly a form of crowd-funding which is used to raise loans for borrowers from the people who want to invest. With P2P lending lenders earn income in the form of interest which can be more than the interest earned by the traditional means. It also helps borrowers in excess of financing which can be difficult from standard financial intermediaries. It enables individuals to borrow or lend money without any intermediary. Through this, lenders get higher interest through lending money instead of savings and borrowers enjoy funds at lower interest rates. Under this process, an online platform is used where borrowers and lenders register themselves. Before the participation Due-Diligence process is carried out. Now, all P2P platforms are considered as Non-Banking Financial Companies and regulated by the Reserve Bank of India (RBI).

P2P lending companies operate online with lower overhead in comparison to traditional financial institutions. This concept is more concerned with savers getting higher interest through lending instead of savings and borrowers to get lower interest rates. Borrowers can be either individuals or small businesses. It is a crowd-based system to raise loans and under this process, repayment is done with interest.

It is an online system which brings borrowers and lenders together on one platform, for matching the demand and supply of the finance. The nature of the funds raised is unsecured. In this, interest paid is either fixed by the online platform or through the mutual agreement between the parties. Their earnings are through charging fees from lenders and borrowers.

Under p2p lending, fees paid by the borrowers are either fixed at a flat rate or as a percentage of the loan amount borrowed whereas lenders pay an administration fee at a fixed rate or additional fees if they avail any of the additional facilities; such as legal advice, etc.

This platform is involved in the collection of the loan repayments and assessing the creditworthiness of the borrower. SEBI is the market regulator, in a case of equity, debt, and fund-based lending. However, under the P2P lending, banks will be the market regulator.

Characteristics

P2P lending is a platform which allows individual investors to lend money online to individual borrowers. Peer to Peer Lending provides lower rates of interest to borrowers and high returns to investors.

Peer-to-peer lending is a fast developing market for individuals and small businesses but involves new risks for both lenders and borrowers. It is a platform which connects savers and borrowers directly and transfers the funds from the saver to the borrower. It allows the borrower to repay the money with interest according to the agreed contract.

Here are the following characteristics of peer-to-peer lending:

  • Online Transactions;
  • Prior relationship between lenders and borrowers is not necessary;
  • It is conducted for profit sometimes;
  • In case P2P platform allows lenders may often choose which borrowers to invest in;
  • Loans are the securities which can be transferred to others, either for debt collection or profit, though not all P2P platforms provide transfer facilities or free pricing choices and costs can be very high.

With the emergence of internet and e-commerce, it has become possible to do away with traditional financial intermediaries and that people may be less likely to default to the members of their own social communities, the emergence of new intermediaries has proven to be time and cost-saving. Extending crowdsourcing to unfamiliar lenders and borrowers opens up new opportunities.

Here are the following services provided by the most peer-to-peer intermediaries:

  • It is an online platform which enables borrowers to attract lenders and to identify and purchase loans that meet their investment criteria;
  • For loan approvals and pricing, development of credit models;
  • Verify borrower’s identity, bank account, employment, and income;
  • Perform borrower credit checks and filter out the unqualified borrowers;
  • Processing payments from borrowers and forward those payments to the lenders who invested in the loan;
  • Providing customer service to borrowers and attempting to collect payments from borrowers who are in default;
  • legal compliance and reporting;
  • Finding new lenders and borrowers.

Importance

P2P lending platforms rely on technology because with the lack of accurate technology it can be cumbersome. With the past few years, this model is helping in revolutionizing the global financial market and reshaping the finance industry with new and innovative modules introducing new lending services. The custom-designed P2P lending platform is considered as the best alternative for the old-style exercise of borrowing money from banks and nonbanking financial institutions.

Instead of approaching banks and applying for loans, this P2P lending platforms can be used, where we only need to provide few necessary information, all from sitting at home/ office and within hours our loan is processed and approved as we all are aware of the time-consuming process of banks for approving loans.

Peer to Peer Lending in Global Scenario

In countries such as Australia, Argentina, Canada (Ontario), New Zealand, United Kingdom, France, Germany, Italy, and the USA it is partially or fully regulated whereas it is banned in Israel and Japan. However, China has the largest P2P market in the world, with hundreds of platforms offering diverse services, but currently, the sector is not regulated.

As per the record in the year 2015, the global cumulative lending was measured at 4.4 billion GBP through the P2P platform whereas it was recorded at 2.2 million GBP in 2012 which shows a significant increase.

 In the global market Peer to Peer lending is perceived differently by different countries:

  • Exempt market/ lacks definition

P2P lending is either considered as exempt market or there is no definition of P2P in the legislation in countries such as China, Egypt, and South Korea. However, there are certain regulations to protect borrowers from unfair interest rates, unfair credit provision, and false advertising;

  • Intermediary Regulation

In countries where P2P is considered as intermediaries are regulated under the jurisdiction such as Australia, New Zealand, Canada, and the UK. The regulations establish rules and requirements to determine how the platform should conduct its business;

  • Banking Regulation

P2P lending platforms are required to be registered as banks due to their credit intermediation function in certain countries such as France, Germany, and Italy.

  • US Model

In the United States of America, two frameworks exist- one at the national level through the Security and Exchange Commission (SEC) and the other at the state level. Certain states ban such lending, while the other put a limit on a number of funds being raised.

  • Prohibited

In some countries, P2P lending is prohibited in their legislation such as Israel and Japan.

United Kingdom

In the world, the first company to offer peer-to-peer loans was Zopa. Since February 2005, this company has issued loans in billion. In August 2010 Funding Circle became the first peer-to-business lender and offering small business loans.

Both Zopa and Funding Circle are members of the Peer to Peer Finance Association.

Here are the following top three peer-to-peer companies in the UK in June 2012:

  • Rate Setter,
  • Zopa
  • Funding Circle

In the year 2014, they have issued loans in millions. In 2012, the UK government invested into British businesses through peer to peer lenders. The intention was to bypass the high street banks, who were not willing to lend to smaller companies but this was criticized for creating unfair competition by concentrating financial support in the largest platforms.

Since April 2016, Investments have qualified for tax advantages through the Innovative Finance Individual Savings Account (IFISA)[2]. The peer-to-peer lending industry has been regulated by the Financial Conduct Authority since April 2014.

United States

The P2P lending industry started in the year 2006 in the US followed by Lending Club and Prosper with other lending platforms soon thereafter. Both Prosper and Lending Club are located in San Francisco, California. Some investors viewed the lack of liquidity for these loans, out of which most have a minimum three-year term, as undesirable.

In pursuant to the Securities Act 1933, Securities and Exchange Commission (SEC)[3] required that peer-to-peer companies register their offerings as securities in the year 2008. Prosper and Lending Club had to temporarily suspend offering new loans while in case of others such as the U.K.-based Zopa Ltd. exited the U.S. market entirely.

NBFC Software

Both Lending Club and Prosper formed a partnership for their notes with FOLIO Investing to create a secondary market, providing liquidity to investors. At this time, Lending Club had a voluntary registration whereas Prosper had mandatory registration for all the members. With this, it addressed the liquidity problem and in contrast to traditional securitization markets, it has resulted in making the loan requests of peer-to-peer companies more transparent for the lenders and secondary buyers who can access the detailed information concerning each individual loan without knowing the actual identities of borrowers before deciding which loans to fund.

It is required for peer-to-peer companies to detail their offerings in a regularly updated prospectus. The SEC makes the reports available to the public their Electronic Data-Gathering, Analysis, and Retrieval system (EDGAR). Following the financial crisis, more people turned to peer-to-peer companies for lending and borrowing as banks refused to increase their loan portfolios whereas peer-to-peer market also faced increased investor scrutiny because of the borrower’s defaults became more frequent and investors were unwilling to take on unnecessary risk.

Lending Club is currently also the world’s largest peer-to-peer lending platform. Lending Club is the largest peer-to-peer lender in US-based upon issued loan volume and revenue as of June 2012, followed by Prosper.

Peer to Peer Lending in India

P2P Lending in India is growing at a faster rate nowadays. Under these borrowers get the advantage of getting funds at comparatively lower rates while the lenders get a better return on their investment in comparison to other conventional lending methods. P2P lending platforms are concentrating on the micro-finance activities catering to the financial needs of the small entrepreneurs. As per the sources in India, there are around 30 new startup P2P lending companies. It has been found that there were around 30 start-up P2P lending companies in India till April 2016.

This platform is helping a huge section of borrowers who have been rejected to qualify for a loan from banks. Peer to peer lending has helped consumers to get loans in categories such as consumer lending, small business lending, and property lending.

Operational Model

NBFC peer to peer shall have a Board approved the policy in place –

  • Set out the eligibility criteria for participants.
  • Determine the pricing of services provided by it.
  • Set out the rules for matching lenders with borrowers in an equitable and non-discriminatory manner.

The outsourcing of any activity by P2P lending platform does not diminish its obligations and it shall also be responsible for the actions of its service providers including recovery agents and the confidentiality of information of the participant available for the service providers.

No loan shall be disbursed unless the individual lender has approved the loan and all concerned participants have signed the loan contract.

Regulatory Framework

Recently on 4 October 2017, Reserve Bank of India (RBI) has released directions on Peer to Peer Lending named “Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017” (“Master Directions”). These are to come into effect immediately. A year ago consultation paper was released by the banking regulator and last month decision was taken to regulate P2P platforms as Non-Banking Financial Companies (NBFCs). NBFCs shall have to obtain a Certificate of Registration from the RBI, subject to a minimum net owned fund of Rs.2 crore who wishes to work as P2P platforms.

Mr. Narendra Kumar head of the Fintech Advisory Division at Enterslice gave a statement that “As P2P Lending was unorganized sector, trust was a key issue for many Investors. And the industry was growing very slowly with no major VC funding happening in this Industry, Now with this new regulation confidence of Investors in P2P Lending Platforms with increase and Industry can see double-digit growth. “

This move will also help achieve the government’s dream of facilitating financial inclusion through greater credit access for small and micro enterprises, which till now were either denied access or were under-served by the traditional financial institutions.

Fund Transfers

Under Master Directions in Annexure I details have been provided on the fund transfer process on a P2P lending platform. Fund transfer shall be through escrow mechanism between the participants on the Peer to Peer Lending Platform and it shall be operated by the trustee. At least two escrow accounts shall be maintained out of which one shall be for funds received from lenders and pending disbursal, and the other for collections from borrowers. Under this process all fund transfers shall be through bank accounts and cash transaction is strictly prohibited. It is important to note that this platform will merely work as a facilitator for borrowers and lenders in an open market.

Prudential Norms

  • Under prudential norms, it is required for NBFC-P2P to maintain a leverage ratio not exceeding 2.
  • Across all P2P platforms, exposure of any lender to all borrowers shall be subject to a cap of Rs.10 lakh.
  • The maturity period of loans shall not exceed 36 months.
  • Exposure of a single lender to the same borrower across all P2P platforms cannot exceed Rs.50,000.

Advantages and Disadvantages

Here are the following advantages of peer to peer lending:

  • Under this, lenders enjoy higher returns in comparison to banks, whereas borrowers enjoy similar cost advantages as compared to bank rates.
  • Lenders are aware of who they’re lending money to and why they need money will give them the sense of personal satisfaction, but also they can choose borrowers who they believe will repay the loan in full and on time.
  • Its websites tend to be active, and the information is exchanged regarding lending and borrowing experiences.
  • It is good for those individuals who want to avoid banks.

Here are the following disadvantages of peer to peer lending:

  • Some borrowers are excluded because of insufficient good credit.
  • The P2P lending platform can demand a lot of work, especially if the loans are funded through an auction in comparison to banks.
  • Although returns to lenders may be higher than those on certificates of deposit, over the period of time it’s not certain that they will be higher than those on a publicly-traded index fund.
  • Everyone does not want their financial story published on the internet due to some sense of personal privacy.

P2p Lending and Crowd Funding

Peer to Peer Lending (P2P) and Crowd Funding in India:

Crowd Funding

It is a method of funding a project or venture by raising the small amount from a large number of people through a portal acting as an intermediary.

There are various forms of crowdfunding such as:

  • Charitable donations that provide intangible benefits but no financial returns and;
  • Equity crowdfunding would fall within the domain of financial markets.

P2P lending

The P2P Lending is a form of crowd-funding which is used to raise loans and these loans are paid back with interest. Under this, an online platform is used which matches lenders with borrowers in order to provide unsecured loans. The borrower can either be an individual or a legal person requiring a loan. The interest rate may be set with the mutual agreement between the borrower and the lender and also by the platform itself.

P2P Lending in India is slowly becoming a very attractive investment option for investors. RBI has already taken an initiative to regulate this sector.

It is also referred to as crowdlending. Sometimes secured loans are offered by using luxury assets such as jewelry, watches, vintage cars, fine art, buildings, aircraft, and other business assets as collateral. There are some other forms of peer-to-peer lending including student loans, commercial and real estate loans, payday loans, as well as secured business loans, leasing, and factoring.

Here are the following routes that could be possibly explored under Security-Based Crowd Funding:

  • Equity-Based Crowd Funding (EBC) – Raising equity through a crowdfunding platform.
  • Debt Based Crowd Funding (DBC) – Raising funds by issuing debentures or debt securities through a crowdfunding platform.
  • Fund Based Crowd Funding (FBC) – Raising funds for pooling under an Alternative Investment Fund (AIF) through a crowdfunding platform.

Risk and Returns

  • To get benefit from higher returns, diversify investments.
  • To benefit from the power of compounding, reinvest payments regularly.
  • Divide overall investment and lend to multiple borrowers within the same category to minimize default.

With all of these strategies, investors can earn good returns without compromising much on the safety of capital.

Documentation

The process of documentation for the lending and borrowing arrangement is facilitated by the P2P platform. The lender transfers money to borrower’s bank account after this 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. This platform also helps in the recovery process with taking follows up for repayments and if required. KYC exercise can be deemed to have been carried out by the banks concerned since all payments are through bank accounts.

Conclusion

These Master Directions provides much-needed closure on the regulation of the P2P sector. However, even though the Directions make reference to an interest percentage to be disclosed mandatorily (charged on the loan), still there is a lack of clarity on the method of computing such percentage.

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Narendra Kumar

Experienced Finance and Legal Professional with 12+ Years of Experience in Legal, Finance, Fintech, Blockchain, and Revenue Management.

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