The ins and outs of peer-to-peer lending

Does an emerging asset class that lets you start in a small way and earn a steady revenue at measured risks appeal to you? Peer-to-peer (P2P) lending offers this and more.

In very minimal terms, P2P lending is a system wherein individuals in need of cash, and those who have some to spare, connect directly, digitally. The connection happens on platforms that have their own checks and balances in place to ensure both sides get a fair deal. There is reasonably good liquidity too, as you can withdraw your earnings monthly or at maturity, or cash out before maturity.

If numbers offer comfort, here they are: India has over 21 licensed P2P lending platforms, who have a combined outstanding loan book of about ₹5,000 crore. Fintech majors such as BharatPe and Cred have entered the segment, which gives it all the more credibility.

To make a start

Once you decide to earmark some of your savings toward this investment avenue, you need to register yourself on one of the numerous P2P platforms available in India. Lendenclub, Lendbox, LiquiLoans, Faircent, Finzy, RupeeCircle and Lendingkart are just examples.

To register, you need to undergo a verification process using Aadhaar and PAN. Once done, you transfer the amount you are willing to invest electronically, and then you’re set to go.

The platforms typically do not use credit scores to assess borrowers. Rather, they use their technology-based checks and balances to sort borrowers under various risk baskets, depending on their income, borrowing history, purpose of taking the loan, and so on.

Pick your option

P2P lending platforms either let you choose the borrowers you wish to lend to, or use algorithms to link you to the borrowers that they deem fit. Once your money begins to get lent, you can expect the EMIs (equated monthly instalments) from the borrowers to land from the very next month. The entire process — your money going from you to the platform to the lender, and then back via the platform to you, with interest — happens digitally.

There are two ways in which P2P platforms let you lend money, Ramprasad Reddy T, Financial Planner with JKR Financial Consultancy Services, told The Federal. “One where your money goes into unsecured loans at high interest rates, and an alternative one where the returns are lower but the risks are mitigated.”

Whichever option you take, the platform will keep you in the loop at all times. You will receive regular emails on whom your money was loaned to, and who deposited EMIs into your account. You can use your account login to check the balance.

The high risk, high returns route

Under the first option, your money will be given out as unsecured personal loans. You can choose whom you are willing to lend to, and also negotiate the interest rate. The borrower, in turn, can accept or reject your offer, or negotiate a better deal. “The interest rate can be as high as 18-20%, and even up to 36%,” said Reddy.

However, he pointed out, the option is highly risky, and the NPA (non-performing assets) rate is often around 40%. “Borrowers often opt for P2P lending only when they’ve exhausted all other options, such as banks and NBFCs (non-banking finance companies), and are pushed to a corner,” he reasoned. “They may not have any collateral left to offer, particularly during COVID times.” Therefore, the possibility of not retrieving the principal, leave alone the interest, is rather high.”

Yet, if you are a mature investor who understands the nooks and crannies of personal loans, it may be a viable way to earn high returns with manageable risks. Prudence and discretion at the time of lending, and spreading the risk — both geographically and across categories of borrowers — may do the trick.

The moderate risk, moderate returns route

The alternative option is where the lenders get lower returns but at far less risk than the previous one. Here, the platforms tie up with banks and NBFCs to handle the borrower end of the scheme, said Reddy.

Regulatory norms do not allow individuals to ‘lend’ to financial institutions, so you still have to transfer your money to the platform. However, from there, the bank or NBFC the platform has partnered with takes over, said Reddy. “They lend the money you’ve put in to their customers and handle the collection. The loans are secured by the partners (banks/NBFCs), who also often undertake to settle NPAs,” he told The Federal.

In this set-up, the borrower’s fixed deposits (FDs) are often used as collateral. “Your money is protected by FDs (collateral) and the financial institution’s default guarantee,” explained Reddy, adding that the institution uses its analysis capabilities to mitigate the risk.

The downside is that the returns are just 11% to 12.25% — which is still higher than what you can expect from a bank deposit or a small savings scheme. Also, if you choose to reinvest rather than take out the dues collected, you can build a tidy corpus.

Regulation is active and well

P2P is fully under the regulatory ambit of the Reserve Bank of India (RBI), which has strict guidelines in place. For instance, the maximum amount you can lend across all P2P platforms is capped at ₹50 lakh. Even to lend above ₹10 lakh, a practising chartered accountant needs to certify your net-worth at a minimum of ₹50 lakh.

Across all P2P platforms, you cannot lend more than ₹50,000 to one borrower, and no borrower is allowed to borrow more than ₹10 lakh at any point of time. The loan tenure cannot cross 36 months. Each loan has to be documented digitally, with both you and the borrower agreeing to the terms and conditions. The platforms typically charge a fee from both parties for the services rendered.

In September 2017, the RBI tightened regulations around P2P lending platforms, stipulating that they register as NBFCs. The P2P operator is not allowed the use the funds — either the money you put in, or the money the borrower returns. Instead, the funds go into an escrow account monitored by a trustee appointed by the operator.

Here are the brownie points

When you lend your surplus funds to earn interest income, you also end up helping someone who actually needs the money. Those who borrow on these platforms are often individuals facing a crunch situation, or a small business owner to whom your money can make a huge difference.

Reports have pointed out how SMEs (small and medium enterprises) worldwide have found a lifeline in P2P lending. So, your money can help businesses, save jobs and boost financial inclusion.