Peer-to-Peer (P2P) Lending : A primer
Shamita Subrata Das (2017 -19)
As the old saying goes, ‘Necessity is the mother of invention’. The 2008 financial crisis led to the necessity of a new way of funding and lending as people began to lose trust on banks and financial institutions. This had led to development of new financial technologies and innovations and one of them is Peer-to-Peer (P2P) lending that has emerged as a suitable alternative to traditional banking channels.
Peer-to-peer lending can be defined as a form of crowd-funding that is used to raise loans for people who need to borrow from people who want to invest. It enables individuals to borrow and lend money without any financial institution as an intermediary, and extends loans to borrowers who are unable to get it through traditional financial institutions. Normally, the borrowers constitute individuals, small tarders, micro and small enterprises, businessmen as well as smaller investors who do not have insufficient sources of money and limited investment channels. Authors have analyzed and considered p2p platforms in different ways. It can be considered as ‘an example of financial disintermediation’; as another ‘technological disruption provoked by Internet’; as a case of ‘collaborative economy’, or even as ‘a platform to give loans to financially excluded people’ or as a ‘spare tyre’ for lending in the economy.
Reserve Bank of India defines ‘Peer to Peer Lending Platform’ as an intermediary providing the services of loan facilitation via online medium or otherwise, to the participants. ‘Participant’ means a person who has entered into an arrangement with the P2P Company to lend on it or to avail of loan facilitation services provided by it.
The following is a basic P2P model.
Peer-to-peer loans are majorly unsecured personal loans. It is also possible to get secured loans which mostly use assets as collateral such as, jewellery or business assets. It can also be used to fund small business, student loans, major purchase or real estate loans. The interest rate on these loans are set in one of the following two ways (i) by lenders who compete to give the lowest interest rate to the borrower, and (ii) by the P2P platform after analysing the credit score of the borrower.
Global Position
P2P lending first emerged in the UK shortly before the financial crisis with the launch of Zopa in 2005 followed by Funding Circle and RateSetter. It started in USA in the year 2006 with the launch of Prosper. Chris Larsen, co-Founder of Prosper, described his company’s offering as an ‘eBay for Credit’ (Business Wire, 2006).
Globally, P2P lending has been significantly growing in terms of volume and number of players. As per the data published by The Peer-to-Peer Finance Association (P2PFA) in the period ending in the fourth quarter of 2017, cumulative lending transacted through P2PFA member platforms exceeded ”8 billion. USA, UK and China markets are the dominant players in this segment. Currently, Lending Club and Prosper are the two largest peer-to-peer lending services who have serviced lending of over two billion dollars. Andrew Haldane, Executive Director Bank of England said in one of his interviews, ‘P2P companies like Zopa and Funding Circle could in time replace high street banks.’
Indian Landscape
P2P lending in India has been evolving in the last few years. India has enormous untapped market potential for financial service technology as more than 40 percent of the population are currently not connected to any formal financial channel such as banks and 87 percent of payments are primarily made in cash. As mobile usage and penetration is expected to increase to 64 percent in 2018 from the present 53 percent, and internet penetration steadily climbing, the growth prospects and potential for P2P lending in India cannot be exaggerated. Moreover, as much as 90 percent of the micro and small enterprises /businesses are still outside the formal net of financial institutions. These gaps in access to formal financial institutions and services offer significant scope to growth and development of P2P lending and enlarge the market base.
Financial innovation has become a focal point for a lot of attention from regulators, and some jurisdictions have decided to take a more active approach in facilitating this innovation. RBI recently came up with guidelines for P2P platforms according to which the companies will need to apply for a NBFC’P2P license and will come under the purview of the regulator. I-Lend, Faircent, AnyTimeLoan, Lendbox, i2iFunding, Milaap, India Money Mart are some of the leading P2P platforms operating in India. Some of the leading P2P platforms claim to disburse loans amounting to ~Rs.1 to 2 crores a month. Outstanding loans under P2P model is estimated to have reached ~Rs.50-60 crores (CARE Ratings, 2017). The platform connects prospective lenders with the borrowers and must collect and authenticate personal as well as financial details of the borrowers. Some of the platforms use their own big data enabled proprietary algorithm to assess credit worthiness of the borrowers. They are also responsible to provide loan recovery assistance as well as legal assistance to lenders in case of defaults.
Benefits & Risks
There are numerous benefits of P2P lending to end users in terms of prices, convenience and accessibility of credit platforms. Firstly, in principle, these platforms have the potential to offer lower interest rates to borrowers and/or higher returns to investors (after including user fees). Secondly, the service is completely online. Therefore, it saves on physical presence and documentation involved in availing normal loan facilities from financial institutions. Extensive use of information technology and online options can allow the platforms to provide a more convenient service for customers. Further, investors can diversify their investment portfolio beyond the traditional options. It also offers the opportunity for investors to support the endeavours of people and may increase accessibility to financial services to underserved segments of the population. However, P2P lending has also been criticised due to high default rates as it tends to attract borrowers with low or no credit, vulnerabilities to operational risks such as cyber risks, third-party risk i.e., any disruptions of outsourced services, fraud-related risks, including money laundering, corporate misconduct, and the ability of the lending platforms (and their investors) to accurately price credit risk and thus deliver acceptable risk-adjusted returns.
Way Forward
P2P Lending industry has recorded substantial growth in the year 2017 and is expanding its customer base. The industry is still in its nascent stage and has also faced certain challenges. However the recent RBI guidelines has given the sector a formal recognition and has helped enhance transparency in the lending process, address concerns related to credit risk assessment, enhance the overall safety perception and encourage use of modern technology.
Financial technology is a revolution which has just started and is nowhere near its peak. There are tons of new ideas and possibilities. P2P lending is one of them which has the potential to significantly enhance the financial inclusion objective and meet the credit demands of a number of underserved people.
The P2P sector is ‘disrupting the traditional oligopolies in retail investment, consumer and businesses lending’. It is emerging as the largest form of alternate finance and provide vital access to finance for individuals, traders, businessmen and SMEs. Sustainable P2P platforms thorough due diligence on borrowers will ensure they offer low risk returns to investors. Going forward, the platforms need to take adequate measures for confidentiality of the customer data and data security, transparency in operations, minimum disclosures to borrowers and lenders mandated through a fair practices code, proper recovery practices and a proper grievance redress mechanism to deal with complaints from both lenders and borrowers and require reporting to the Board. The platforms are also more vulnerable than banks to some operational risks, such as cyber-risk. Keeping in mind the fast pace of innovation and the rapid development of the industry having implications for financial stability ‘ both benefits and risks, regulation of these platforms need not be viewed as a constraint on the sector as a whole. If well designed and proportionate to the risk of market failure, it may support confidence, growth and innovation in P2P lending over the longer term.