Thursday, July 7, 2022
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P2P lending in India and lessons from China

Peer to Peer lending became famous in the last decade. Fintech has massively revolutionised money flow and settlement transactions among the youth. Out of a number of existing fintech models, one is a peer to peer lending. P2P lending platforms act as a middleman between two individuals, the lender and the borrower.

P2P lending is the process of giving money to individuals or businesses as loans through online platforms. Any individual or financial institution can become a lender at these P2P lending sites. In return, they earn interest paid by the individual or business that has borrowed money.

P2P lending operates totally online and they aim to connect such lenders and borrowers. Suppose, a person or lender is looking to put his money somewhere. So, he lends his/her money to another person or borrower who is looking for some funds. Through this, lenders can earn a higher interest rate on their investment that they may not be able to earn from bank FDs or even some mutual fund investments. Also, borrowers get loans at comparatively lower rates.

Further, online NBFC P2P platforms provide easy solutions for borrowers. They might not be getting loans otherwise, say from banks who do a stronger credit check before lending.

These requirements could be anything, say a medical emergency, buying consumer electronics, repaying credit card dues, home renovation, business loans, travel loans, or any such needs. Thus, it is relatively easier to borrow from NBFC P2P platforms as opposed to traditional sources like banks.

On the grim side, the risks attached in these investments for lenders are also higher than other financial assets such as mutual funds, stock market equities, etc.

However, processing and disbursement of the loan amount are much faster at P2P lending platforms compared to applying for a personal loan at a bank. So one might argue that the P2P platform is taking the model of a bank and revamping it to create convenient lending and borrowing environment.

NBFC P2P lending process

NBFC P2P institutions provide an attractive rate of interest to ease the whole process. These platforms have become very famous among individuals and small businesses as it provides a better choice to raise funds.

All P2P lending firms aim for profit. The fees paid by borrowers and lenders are their main source of revenue. They reduce processing time and expenses so that P2Ps can manage to offer lower interest rates for borrowers while providing higher returns on investments, irrespective of market conditions.

To get this service, borrowers need to pay a fixed origination fee, while lenders have to pay an administration fee. It depends on the terms of the NBFC P2P lending platform. The interest rates are usually determined by the platform. In most cases, these rates are set after a mutual agreement between the lender and the borrower.

Generally, the process goes like below:

  1. A borrower goes through a quick soft credit pull with the P2P platform to determine initial eligibility. The platform operator checks their credit history and their capacity to repay the loan.
  2. Then the borrower lists his/her loan, including the interest rate he/she is willing to incur.
  3. Lenders review the listings, according to the terms like
  4. Amount of loan they will offer
  5. Risk grade
  6. Interest rates on offer
  7. Borrower’s profile.
  8. The lenders decide how much they want to lend, in total and separately, to each borrower.
  9. Additionally, lenders also choose the minimum interest rate and select the duration that is suitable for them. However, some investment decisions might be reviewed by the platform operator or the investment manager.
  10. Once lenders have selected the amount from their escrow accounts, it goes into a single escrow account of the borrower and then into his/her bank account.
  11. Most P2P lending platforms charge a fee from both investors and borrowers while some from borrowers, and not lenders. Many portals also may charge a proportion of the ROI from the lenders.

Also Read: The rise of Buy Now, Pay Later

How does the fund transfer mechanism differ in India and China?

China, by 2015 witnessed an exponential growth in this sector and had at least 4,000 platforms of an estimated value of $130.7 billion.

Among the top players in the P2P industry was Ezubao established in 2014. In 2015, it raised approximately RMB 50 billion and provided attractively high returns of 9-15% with no limits on the amount or tenure of the deposit.

However, soon Ezubao turned out to be at the helm of a Ponzi scheme. It duped more than nine lakh investors.

This created chaos in the market. At the same time, similar defaults were made. A lack of laws to govern such a system pushed the People’s Bank of China to come up with guidelines.

On August 24, 2016, the China Banking Regulatory Commission (CBRC) along with the Ministries of the Chinese Government released the Interim Measures on Administration of the business activities of peer to peer lending information Intermediaries (Interim Measures).

P2P platforms had to comply with the Interim Measures within a period of 12 months, including the requirement to engage a qualified financial institution as a third-party banking custodian.

In India, all these risks were taken into consideration by the RBI to avoid the fear of money laundering or usage of such platforms by the concerned people for their benefit. Hence, RBI prescribed escrow accounts for initiating transfer which is to be operated by a trustee.

Regulation in India on NBFC P2P by RBI

RBI recognises NBFC P2P as a non-banking institution involved in the business of a peer to peer lending platform. P2P lending has been regulated to protect the interest of lenders and borrowers.

As per its provisions, an NBFC-P2P should become a member of all CICs (Credit Information Companies) and submit the data at regular intervals so that all payments can be monitored and recorded.

Currently, there are 4 CICs in India — Credit Information Bureau (India) Limited (CIBIL), Equifax Credit Information Services Private Limited (ECIS), Experian Credit Information Company of India Private Limited, and CRIF High Mark Credit Information Services Private Limited.

Every NBFC P2P has to become a member of at least one CIC and submit all previous data.

The credit information of the borrower should be maintained and updated regularly, either monthly or at shorter intervals, as the mutual understanding between NBFC P2P and CIC.

Appropriate measures should be taken to ensure that the credit information of borrowers is maintained accurately and completely.

Required declarations in the agreements with the participants stating that they have consented to provide the required credit information should be placed.

Benefits of Investing in NBFC P2P

  1. The process of investing is very simple. Whether one wants to invest or borrow, one can start anytime and from anywhere right from the comfort of home.
  2. The amounts involved are relatively lower. The minimum amount that you can lend or borrow is Rs. 2,000 to Rs. 5,000. It depends on the platform you are using.
  3. P2P lending companies provide a detailed analysis of the profiles of borrowers. So the lender can decide easily.
  4. Financial inclusion: banks and money lenders have been the source of credit in India. But their presence was limited and paperwork was time-consuming. So a large part of India’s population remained unbanked. NBFC P2P has helped individuals transform their savings into an asset class that can help them get a good return on their investment. P2P platforms use technological algorithms that consider data points and list borrowers. They would otherwise be denied by banks and the organized financing sector. Also, borrowers can move away from traditional sources of financing and become a part of the mainstream economy, accessing cheaper, faster finance.
  5. Low-Cost and Simple Loans: NBFC P2P removes intermediaries and their commission which in turn lowers the rate of interest. In India, the advantages of P2P lending became more evident during the IL&FS crisis when loans from NBFCs became impossible. Due to its paperless & virtual process, the costs of administration and overheads are also low. Thus the cost of financing became lower and the process simpler.
  6. Privacy: RBI regulations ensure that the technology used by NBFC P2P is highly secured and safe. Investors and borrowers do not know each other’s identities. Only the information that is necessary to complete the transactions is shared. Further, RBI required these institutions to keep updating the system.
  7. Buyback guarantees lower risk and acts as a protective layer over the investments. This is needed when a borrower misses repaying for a certain number of days. After 30 to 90 days, the loan originator is obligated to buy back the loan either wholly or in part. Depending on the buyback guarantee, investors will be compensated for the remaining principal, some or all of the interest, and penalty fees. However, one should go through the agreement thoroughly to know how the payments will be calculated.
  8. Diversification of investment: if you are looking to diversify your investment from mutual funds and equities, this might be a good option hence minimising the overall risk.

Suggested: How do tokenization and encryption secure digital payment?

Risk of NBFC P2P investment

Investing in the P2P lending sector gives fair returns, however, the risks associated with such investments are something that investors should be aware of. Therefore, market and regulatory risks cannot be ignored when investing in this sector.

  1. Borrower Related: China has a history of fraudsters conning an online lender by submitting various loan applications with fake profiles on P2P platforms. It can be copied by the fraudsters on P2P platforms in India as well. In P2P lending, there is a risk the borrower defaults in paying back the loan. There are possibilities of the borrower’s credit profile getting worse after borrowing money from multiple lenders.
  2. Platform related: The P2P platform might not have a proper process of due diligence or it decides to shut the operations while still in the process of getting registered with RBI. Some of the P2Ps not registered with RBI offer guaranteed high returns in their advertisements and websites. So one must be aware of the platforms too.
  3. Criteria of Calculations: one should know how the platform calculates what the loan to a particular borrower will earn or how the risk profile is determined as these are complex processes.
  4. Dependence: You are dependent on the platform to provide you with information about borrowers. Some important things like how the rate of return is determined also involve a complicated process for an individual. For this, funds are deposited and withdrawn. Interest rates are different for different durations. Also, when a borrower defaults the account would go into collections. However, the platform does not provide information to investors on what was collected from the defaulted borrowers.
  5. No Tax Exemptions: you have to pay tax on the interest earned by declaring it in your annual ITR filing.
  6. Recovery Mechanism: the efficiency of the recovery mechanism employed by the P2P firm to recover your investment is still unknown. Also, the platform may not be hiring qualified on-field debt recovery agents in spite of charging fees.
  7. Lower Liquidity: these investments are much less liquid than equities, mutual funds, or bonds because of long-time horizons. So, your cash flow depends on the loans you opt to give. Most often, it is impossible to withdraw from the agreement before time. Also, you would have to wait until the borrower repays them naturally, even if the NBFC P2P provides a facility for you to exit and sell loans to other lenders. Though you do not lose your money, it can be inconvenient at times.
  8. Technology Risk: Some P2P platforms regard cybersecurity as a factor that could have a negative effect on the sector. The entire P2P transactions are done online, so a cybersecurity breach can be a real risk. P2P lending became famous around the recession of 2008. It takes a longer time than 15 years to establish a new asset class as a credible investment opportunity. So, the sector is yet to become more relevant.
  9. Illegal instant loan apps: As per a report, in China, a college student in Henan committed suicide as he could not afford to pay the debt of $90,000. To borrow such a large sum of money, he stole the identities of his 28 classmates. Similarly, a P2P lending app, ‘Jiedaibao’ launched “naked loan” in 2016. Female college students can send their nude photos holding their ID. If they did not pay the loan, this photo was used to threaten them. Even QQ and Wechat were used to issue such loans. Such heavy debts lead to the exploitation of borrowers. Even in India, some people were given death threats as they missed to pay back the dues. This incident is from 2020. The Central Crime Branch of Chennai Police arrested two Chinese for operating instant loan apps illegally. This sector is heavily unregulated and some apps are fraudulent and deceptive. In such cases, it becomes the sole duty of lenders and borrowers to check up on their authenticity.

Also Read: Digital Payment Fraud Prevention with 3D Secure 2.0

Conclusion

The RBI has tried to ensure that Indian regulations are made from the lessons learnt from the different P2P models. The Master Direction is well elucidated for capturing the market dynamics of P2P lending structures and regulating the industry to not let investors and borrowers get duped.

Internet-based financial intermediary apps that solve the problem of traditional banking by lending on a peer-to-peer basis will eventually prevail. It is because this is economically better as compared to the traditional banking business model.

However, a uniform and dedicated regulation for making lending through P2P is needed. It will give the platforms and their users the legal confidence to invest and expand their operations.

Also, a host of Chinese companies are looking for investment opportunities in the Indian P2P lending segment. Only certain clarifications on Master Direction from RBI is pending. Based on the same, further disruptions and regulations could be assessed.

We will keep an eye on this and will keep updating this space.

References

  1. https://www.mondaq.com/india/financial-services/815384/peer-to-peer-lending-in-india-a-chinese-lesson-well-learnt
  2. https://fintechnews.sg/5541/lending/chaos-among-chinese-school-students-taking-out-unregulated-loans/
  3. https://nbfclicenseindia.com/blog/nbfc-p2p/
  4. https://www.indiatoday.in/india/story/deep-dive-how-china-based-money-lending-apps-devastating-gullible-indian-borrowers-1756569-2021-01-06

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