Why In News?
Fintech platform CRED has launched a peer-to-peer lending feature called CRED Mint.
- Fintech platform CRED Friday announced the launch of a peer-to-peer (P2P) lending feature called CRED Mint — a service that will allow the company’s users to lend money to other users and make a 9% interest per annum on the amounts they give out as loan.
- For its P2P lending feature, CRED has tied up with RBI-approved non-banking financial company Liquiloans.
- Some of the major companies operating in this space include RupeeCircle, Finzy, IndiaMoneyMart, etc.
What is Peer-to-Peer (P2P) Lending?
Peer-to-peer lending is a form of direct lending of money to individuals or businesses without an official financial institution participating as an intermediary in the deal. P2P lending is generally done through online platforms that match lenders with the potential borrowers.
How does peer-to-peer lending work?
Peer-to-peer lending is a fairly straightforward process. All the transactions are carried out through a specialized online platform.
The steps below describe the general P2P lending process:
- A potential borrower interested in obtaining a loan completes an online application on the peer-to-peer lending platform.
- The platform assesses the application and determines the risk and credit rating of the applicant.
- An auction is conducted where the lender can make a bid for a borrower’s loan requirements. Then, the applicant is assigned with the appropriate interest rate from selected successful bidders.
- The applicant can evaluate the suggested options and choose one of them.
- The applicant is responsible for paying periodic (usually monthly) interest payments and repaying the principal amount at maturity.
The company that maintains the online platform charges a fee for both borrowers and investors for the provided services.
RBI Guidelines on P2P Lending
RBI had in 2017 declared that, all peer-to-peer lending (P2P) platforms would be treated hereafter as non-banking financial companies (NBFCs -P2P) and will be regulated by the RBI.
The P2P lending is regulated by the Master Directions for NBFC Peer to Peer Lending Platform issued by the RBI in 2017.
- Only an NBFC can register as a P2P lending platform with the permission of RBI. Every P2P lender should obtain a certificate of registration from the RBI.
- Every company seeking registration with the Bank as an NBFC-P2P shall have a net owned fund of not less than rupees 2 Crore or such higher amount as the Bank may specify.
- An NBFC-P2P shall become member of all Credit Information Companies (CICs) and submit data (including historical data) to them.
- NBFC-P2P shall keep the credit information (relating to borrower transactions on the platform) maintained by it, updated regularly on a monthly basis or at such shorter intervals as may be mutually agreed upon between the NBFC-P2P and the CICs.
- Any person including an individual, a body of individuals, a HUF, a firm, a society or any artificial body, a company can participate in the P2P lending platform.
- The aggregate exposure of a lender to all borrowers at any point of time, across all P2P platforms, shall be subject to a cap of ₹ 50,00,000 provided that such investments of the lenders on P2P platforms are consistent with their net-worth.
- The lender investing more than ₹ 10,00,000 across P2P platforms shall produce a certificate to P2P platforms from a practicing Chartered Accountant certifying minimum net-worth of ₹ 50,00,000.
- Aggregate loans taken by a borrower across all P2P platforms subject to ₹10 lakh
- Exposure of a single lender to one borrower, across P2P platforms, capped at ₹50,000
- Maturity of the loans is a maximum of three years.
Advantages and disadvantages of peer-to-peer lending
Peer-to-peer lending provides some significant advantages to both borrowers and lenders:
Higher returns to the investors: P2P lending generally provides higher returns to the investors relative to other types of investments.More accessible source of funding: For some borrowers, peer-to-peer lending is a more accessible source of funding than conventional loans from financial institutions. This may be caused by the low credit rating of the borrower or atypical purpose of the loan.
Lower interest rates: P2P loans usually come with lower interest rates because of the greater competition between lenders and lower origination fees.
No mandatory collateral: Corporate borrowers have the ability to obtain P2P-loans without providing collateral.
Extra flexibility that P2P offers over banks: Most platforms allow borrowers to cancel loan contracts prematurely without paying a prepayment penalty
Cheaper credit: Due to low administration cost, P2P is able to provide cheaper credit than banks.
Nevertheless, peer-to-peer lending comes with a few disadvantages:
- Credit risk: Peer-to-peer loans are exposed to high credit risks. Many borrowers who apply for P2P loans possess low credit ratings that do not allow them to obtain a conventional loan from a bank. Therefore, a lender should be aware of the default probability of his/her counterparty.
- Non-repayment of loans - Given that P2P lending is a form of unsecured loan, there is no guarantee put up by the borrower for the lender to redeem in case of a default. However, the unsecured nature of the loan is also the reason behind the high return on investment compared to other debt instruments.
- No insurance/government protection: The government does not provide insurance or any form of protection to the lenders in case of the borrower’s default.
- No uniform standards to calculate profit returns: The methods used for calculating the risk-adjusted net returns differ considerably from platform to platform because national laws and regulators have yet to define a common standard for measuring the performance of P2P-loan investments.
- Lack of transparency regarding credit assessment: There is lack of transparency about how platforms assess credit. Borrowers may not know what kind of data their platforms are using and how credit ratings are calculated.
Practice Question:
Q. What is peer to peer (P2P) lending? Discuss the risks and opportunities in P2P lending. (400 words)
