P2P lending, can it really Yield up-to 36% returns?

Do you have extra savings? Thinking of investing in stocks, bank-FD or Mutual Funds, wait there is one more option. P2P (peer-to-peer), an alternate lending platform can offer you highly attractive returns up-to 36% on investments.

Now, what is this P2P lending and how is this an opportunity to invest?

A P2P lending enables the ‘individuals or small businesses’ to borrow funds directly from another ‘individual or institutional lenders’ over a common platform with an easy-to-go online process. It eliminates the traditional way of borrowing from financial institutions by allowing anybody to lend directly through the P2P platform by choosing a borrower of their choice listed on the platform at an interest rate suitable with the borrowers’ profile. (below is a screenshot of some borrowers profile at a P2P platform)

Borrowers profile from a a P2P platform- i2i Lending

A brief look the current Indian P2P platforms

The current size of Indian P2P market is around Rs 200 crore. In India all the P2P platforms are required to get registered with RBI as NBFC-P2P as per RBI’s new circular released in 2017 stating statutory guidelines for such platforms. Currently around 19 registered NBFC-P2P platforms exist in India like Faircent, i2i-Lending Lenden, RupeeCircle, IndiaMoneyMart and many more.

Why P2P lending came into existence?

The traditional banking system offers a loan that involves an extensive procedure and paper-work along with risk profiling of the borrower and thereby eliminating the high default rated applications to control the NPA’s (Non-Performing Assets). For instance a person goes to a bank for a loan, but due to bad CIBIL score and inability to fulfill the banks criteria to avail credit, gets rejected. Where will such individuals go to fulfill their rising money demand? One solution for such money problem is P2P platform where individuals with high risk unable to get money from existing banking system can get credit with a smoother loan application & approval process.

Before entering the P2P market one should know how the RBI’s regulations are helping in mitigating the risk associated with the borrower and lender on such platforms? The next question that needs to be addressed is how beneficial is this alternative lending platform?

  • Diversifying the Risk- As per the guidelines there is a lender limit of Rs.10 lakhs across all P2P platforms, where no one lender can have an exposure of more than Rs. 50,000 to a borrower. This helps in diversifying the risk of the lender by spreading the lending portfolio and not concentrating it to one particular borrower.

  • As per the guidelines there is borrowing limit of Rs.10 lakhs by one individual borrower across all P2P platforms. This limits the excessive borrowing and keep the ability to repay in check.

  • High Flexibility-The maximum tenure of lending cannot exceed 36 months. With no minimum cap of loan amount and tenure, individuals seeking loan say for 40 days or one month with a minimal requirement of say Rs.5000 can get listed on such platforms. Such mechanism provides high flexibility. (screenshot of some borrowers profile at a P2P platform)

  • Security-All registered NBFC-P2P have to report the borrowing and repayments to credit agencies. This gives a high security to the investor as, a third party monitoring on the data can keep the P2P platforms in check and identify any fraud or illicit activities at an early stage.

  • Provides Transparency-According to RBI, P2P lenders have to put out the default numbers on their websites. .

  • Micro-Financing-Individuals along with institutions can also lend. With no minimum cap on lending, individuals like students, housewives, working professionals etc. can become a lender by lending say just Rs.5000 as per their convenience and earn interest income.

  • Legal Assistance-P2P NBFCs are offering legal assistance to lenders on their platform in case of a repayment default, this implies that there is no assurance of recovery from the platform. It only acts as an intermediary.

The above explained norms laid by the RBI two years ago, are to control the risks associated with this business model and keep them low. These regulations are a step towards making the P2P platforms a less risky zone for borrower as well as lender.

However, one cannot ignore the inherent risk associated with these platforms

These P2P platforms also have a side that makes them a risky bet. So the first question that comes is how as an investor can I be careful? In order to avoid the risks one must know what are the risks associated with this type of business model. Let’s understand -

  • A borrower with low risk profile will get loans at a lower interest rate while one with higher risk profile will have to pay high interest rate. Currently the interest rate on such platforms ranges from 12% to 36%. (The banks in India offers personal loans ranging from 10% to 14% interest rate)

  • Tempting high interest rates make the lenders choose risky borrowers thereby ending up losing their money due to borrowers default.

  • Some NBFC-P2P platforms like Faircent has a default rate of 5.4%, i2i funding another NBFC-P2P has a default rate of 3.4%; Lenden Club’s default rate is 5.2%. On the other hand the bank default rate on personal loans ranges from 1% to 2%, implying that the chances of default is 2.5-3 times more than that of a bank.

  • High Risk Borrowers-According to data given by these platforms on their websites show that the loan portfolio holds a huge percentage of high risk borrowers (ones with an interest charge ranging from 18%-28%). As you can see in the below image that 45% of the portfolio is at an interest rate of > 23%, and around 9% of loans given at 46% interest rate, that's huge. It is difficult for such loans to get recovered due to the sky high interest rates.

i2i-Funding Loan Portfolio-Mix

  • Extended market base to tier-2 and tier-3 cities, which makes it difficult to recover money by our own as these platform have limited recovery procedures.

  • The existing P2P players have requested the RBI to extend the borrowing and lending limit in order to attract more customers and more SME’s (Small and Medium Enterprises). This might increase the exposure amount and might attract more risky players.

Looking at the above risk factors, is this really a good idea to invest your money as a lender to these high risk profiles? Well, it doesn't look like a good idea as one must take care of the associated risk factors and recovery support systems before putting your hard earned money in it.

What does the history tells us about P2P platforms?

After understanding the current scenario of P2P in India let us have a look at its history. It isn’t the first time that an industry is booming in India after having matured in some other country, like manufacturing.

About a decade ago the P2P market started in China. Further between 2011 and 2015, this market segment boomed due to its benefits of easy borrowing and lending. In the later years problems associated with such platforms started to show up, leading to its downfall, where many people lost their life’s savings.

In China around 4,500 P2P lending platforms have closed shop since 2013 mainly due to the frauds that took the industry down. A few popular cases of P2P frauds in China are- Lianbi Finance, a large Shanghai-based lending platform that collapsed and defaulted on investments estimated to be 844 million Yuan from nearly 4,000 investors across China; Quark Finance another P2P company had $556 million of outstanding unpaid loans cumulative transactions on the platform totaled $2.3 billion was siphoning money illegally. There was high level of fund misuse, unrealistic return figures and high return rates that were major cause of the problem.

What led to the downfall of such great idea in China?

Well the answer can simply be summed up as ‘high-default-rates due to lack of stringent regulations’. The industry regulating norms for P2P in China came at a very later stage after an ample amount of frauds took place.

But how is India’s P2P market different from China? Did India learn from China’s mistakes? Yes, India did learn from China, as in India RBI issued regulatory norms for P2P platforms at a nascent stage of the industry. Any change in policies and business model are governed by the regulated authorities, thereby keeping it under the radar. Now the question is , whether this new online model of borrowing and lending going to sustain in India or is it just another new big idea ready to blow-up the financial system in coming decade as it did in China?

Thank You!

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