Rise of P2P lending platforms: Why users need to exercise caution before diving into it

Noida-based Akash Garg has built a fairly diversified investment portfolio. From fixed deposits to gold, to equities, and real estate, his investments span various asset classes. But he is always on the lookout for alternative investment avenues beyond the traditional ones—options that can offer him higher returns within the boundaries set by regulators, of course.

So, when a friend introduced him to peer-to-peer (P2P) lending a few months ago, he was intrigued. This is a method by which an investor lends directly to borrowers, but unlike with the moneylenders of yore, there is an added layer of a technology-powered intermediary to facilitate this transaction.

Excited, Garg signed up. “While my fixed deposit provides a return of 7 per cent, the P2P lending platform offers me a return of up to 12 per cent, along with the added advantage of free withdrawals anytime,” he says.

In simple terms, P2P lending is a transaction in which a person lends to another person through a Reserve Bank of India (RBI)-regulated non-banking financial company (NBFC) platform. Borrowers apply for loans on these platforms instead of traditional banks, and they are matched with individual investors willing to lend. The platforms act as intermediaries, facilitating this transaction and managing repayments, and charge a fee in the range of 1–3 per cent for their efforts.

For an investor, a P2P platform offers a potentially higher rate of return than a fixed deposit with a bank, though it does not guarantee this. The platform also identifies and vets the borrower. For the borrower, the platform provides an alternative source of funds with potentially fewer hassles than the elaborate process required to access funds from a bank.

Though not a new concept, P2P lending became popular globally after the 2008 financial crash, and by 2014 it had found currency in India, prompting banking regulator RBI to introduce regulations in 2017. And going by the numbers, Garg isn’t an outlier. “Till date, at least 3-3.5 million investors have opened investment accounts across P2P lending platforms. While this may seem small compared with mutual funds, it is significant. P2P lending platforms in India have invested approximately Rs 20,000 crore in loans, with a combined outstanding AUM (assets under management) of around Rs 4,000 crore,” says Bhavin Patel, Co-founder and CEO of LenDenClub, a P2P platform that was founded in 2015.

That momentum is expected to accelerate with growth projected to hit double digits. According to a report by IndustryARC, a market research firm, the Indian P2P lending market is expected to swell to $10.5 billion by 2026, growing at 21.6 per cent between 2021 and 2026.

These numbers seem enticing, but it’s crucial for investors to be aware of some key factors before jumping in enthusiastically, to avoid unpleasant surprises down the road.

Connecting the two

To participate, both borrowers and lenders must register by filling out an online form and submitting know-your-customer (KYC) documents, along with a bank account statement. Upon registration, the lender transfers the desired amount to an escrow account, from which funds are then directly transferred to the bank accounts of borrowers chosen by the lender.

On certain platforms, an investor has the opportunity to access loan information, such as the borrower’s profile, credit history, and purpose for seeking the loan. However, on other platforms, the available details may be more restricted.

While signing up you must remember, though, that each platform might have specific requirements. For instance, MobiKwik has a minimum investment amount of Rs 1,000, whereas at Faircent it is Rs 25,000. There is, however, a cap on the maximum amount you can invest through these apps. According to RBI guidelines, you can invest only up to Rs 10 lakh through these apps; and for amounts exceeding that, a net-worth certificate must be furnished, after which you can invest up to Rs 50 lakh.

At present, around 26 companies such as LenDenClub, Faircent and LiquiLoans IndiaP2P, are registered as NBFC-P2Ps with the RBI. Then there are financial technology companies, or fintechs, such as BharatPe’s 12% Club and MobiKwik Xtra that have tied-up with NBFC-P2Ps to offer lending services to their customers.

There are fintech companies like BharatPe that offer both borrowing and lending services with interest rate up to 12 per cent. It also gives investors the opportunity to lend to the company’s merchants, whose creditworthiness they can check based on business cash flows and facilitate repayment by deducting a small portion from their daily payouts. The funds borrowed through the “12% Club” initiative are facilitated by a standard NBFC like Hindon Mercantile, which provides loans to consumers. Currently, BharatPe has waitlisted borrowers on the 12% Club platform.

Know thy debtor

When investing in these platforms, it is critical to understand who you are lending to. This is because each player uses different criteria to select borrowers. For example, while some platforms ask for a credit score of 790 and more, and there are some that accept sub-par credit scores. There are also some that lend to small and medium enterprises seeking unsecured personal or business loans. Consider this, LiquiLoans has a partner ecosystem with upGrad, CRED, and Livspace.

“We use an advanced, technology-driven process of verification that assesses a potential borrower on more than 120 criteria and over 400 data points, based on the personal or financial information and documentation provided. We also undertake physical verification at both the residence and the workplace of the borrower,” says Rajat Gandhi, Founder and Chief Executive Officer of Faircent.

All the data collected is then processed with an algorithm to evaluate a borrower. That evaluation then determines the amount, tenure, and interest rates to be assigned for each loan. Besides, borrowers are also classified in risk buckets based on the evaluation ranging from low, medium, high, to very high with interest rates in the range of 12–35 per cent.

Determining returns

How do these platforms decide interest rates to be paid to investors? The math goes something like this: If the money is lent to the borrower at an annual interest rate of 23 per cent, assuming the average loan tenure is six months and non-performing asset (NPA) rate for every cycle of around 4 per cent, and platform facilitation fees of 3 per cent per annum, then the returns for lenders or investors works out to 12 per cent per annum (23-8-3=12).

One more thing you must keep in mind is that the interest rate you are offered by a P2P platform is not guaranteed because it is directly impacted by the NPAs of the portfolio. So, it is important that you check the profile of borrowers and their NPAs when you choose a P2P lending platform.

It is better to go with players that disclose NPA numbers on the portfolio performance page on their website. However, while NBFC-P2Ps come under the RBI’s purview, there is no standard format for disclosures, which makes access to this information a bit tricky.

Another way to find out whether a platform is trustworthy or not is to check its track record and reputation, especially to see if it provides information about borrowers, including credit profiles, loan purpose, and interest rates. Also check for disclosures of fees, charges, and potential risks.

What happens if a borrower fails to pay? “A P2P platform can help lenders recover money if a borrower defaults and can also take legal action against the defaulter. However, sometimes it may not yield any result. The investor might lose all of their investment in such a case. Fraud, platform failure, and a lack of liquidity are additional risks,” says LenDenClub’s Patel.

But the platforms are working on ways to mitigate such risks. “Many players deploy robust artificial intelligence (AI) and machine learning (ML) algorithms to provide the lenders’ funds to creditworthy borrowers. The technology helps hyper-diversification of investment funds to as low as Rs 1, which tremendously mitigates risk while enabling the lender to earn high returns on their investment. For example, if Rs 1 lakh is divided into 50,000 loans with just a Rs 2 exposure per loan, it will not impact the returns of the portfolio,” says Patel.

Look before you leap

P2P lending has gained popularity because of the higher returns offered compared with bank fixed deposits. But there is a catch. While bank deposits have an insurance cover of Rs 5 lakh, there is no such guarantee for investments made on a P2P lending platform.

“Compared with fixed deposits, P2P lending carries more risk (hence the higher returns), but it is not as volatile as equities, where investors can witness significant fluctuations within weeks. Investors must recognise that although P2P lending offers appealing returns, they are not guaranteed,” says Raj Khosla, Founder and MD of MyMoneyMantra.com, a financial services company.

Finally, you must understand the timeline of payout offered by the P2P player—whether it credits interest daily, monthly or at the end of the tenure. This is important to know as the payout varies from player to player and should be chosen according to your needs. Moreover, a few players have the option of auto-renewal. If you do not want to stay invested for another year, make sure to do not select the option so that you have money when it is needed.

P2P platforms have made lending to individuals simple and fast. But it is prudent to diversify your portfolio and not bank on just this one avenue.

@teena_kaushal