Peer to Peer lending or Crowd Funding or P2P Lending is gaining awareness and I receive a lot of queries from our readers whether they should invest through P2P mechanism or websites. Well, P2P is a new concept in finance and started by a company named Zopa in the UK. Since then now it has acted as a credit facility for seekers of funds and investment option for lenders of the funds. So what is in it for us? Let’s try to understand?
What is P2P lending?
Over the last few years, a few main types of crowdfunding investments (investment made by the crowd or a loan arrangement where loaner/loanee do not know each other) have emerged. This include:
- Equity Investments: You can invest in a company
- Real Estate Investments: You can invest in property
- Peer to Peer Lending: You can loan money to others
- Specialty Investments: Investing in even more alternative ways
In P2P lending, the flow of funds is from lender to borrower and goes through a mediator in between, which normally is an online/Internet Company. So this online company matches the lender and borrower. In India, there are about 30 companies operating in P2P lending.
Some of them are Loankuber, Lendbox, Faircent, I2iFunding etc. P2P lending is also called social lending as it does not involve any formal company like a financial institution or bank in between.
How does P2P lending works?
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This can be understood by this flow graphic:
Important Points to see in P2P lending mechanism
- Lender and borrower both need to register at the marketplace (platform) with their KYC documents.
- Borrowers especially corporates need to provide more documents like income statements and other documents related to business.
- Some platforms offer secured loans also and being a borrower you can pledge your assets for a loan.
- The interest rate is in the range of 5% to 36% depending on the credit profile of the borrower.
- On some platforms, the lender decides the interest rate by looking at the profile of the borrower. The quotation is passed to the borrower by the platform.
- The fees charged by the platform is from 2% to 6% as the borrowing rate goes up. Some platform charge fixed fee for registration also.
- Minors cannot be a lender or borrower. So if you are taking it as an investment, it cannot be in name of minor.
- All platform claim to verify the borrowers at the time of registration personally, professionally and socially but do share what process they follow or which agency they engage.
- The lender can invest as little as Rs 10000/- and borrower can also borrow small amounts. In fact, the rate is lowest for such borrowers and lenders. Small amount attracts a new
- Some platform says that they do RBI KYC. We all know what that is- ID and address proof. Can be rigged easily by someone with bad intentions.
Points in favor of P2P lending
- As an investor, the P2P lending is beneficial if you are looking for more interest rate than bank savings account and one year FD. If you are looking for more returns than 12%, it is highly risky. Why would someone take a loan from you and pay more than 12%, when banks will also lend around the same. Maybe he is not getting the credit due to poor CIBIL or borrowing history.
- As a borrower, if you looking for short term small amounts (ideally I hate these things), you can look at P2P. But in case you need large sums for the business etc bank should be your first choice.
- P2P lending involves less documentation compared to loans by banks.
- Easier approval process. Risky if you are a lender.
- As a lender, you have the option to invest your paybacks by giving instructions to the P2P platform.
Points against P2P lending
- It is mostly limited to personal or cash loans. Other loans are not available.
- It is not regulated by RBI or SEBI or any other institution in India. Although, RBI has a paper issued for it and guidelines are expected on these investments and companies. (Follow-up Note: on 20 Sept 2017 RBI issued a notification that all P2P companies will be classified as NBFC or Non-Banking finance Companies. However detailed guidelines are still awaited)
- No guarantee against non-repayment or default. All platforms have their guidelines regarding penalties and process related to delay or default in payment. But no one covers it for you.
- Borrowers with bad credit history can get loans and they continue to spoil the economy.
- It is being marketed as debt investment option, whereas one can lose his capital in these investments. Diversification also does not help as loans are of the same nature.
What do I think? – At the moment
I have gone through a lot of material on P2P lending In India and Internationally. The 2 major point of contention are:
- In absence of a regulator, this is like a no-rule business. There are no rules for who can be a platform company. What is the capital requirement? Management quality or background check for the promoters? What are the duties and obligation of the platform companies or its management in case of a default? It is like anyone-can-open-a-bank-scheme. (Awaiting RBI Guidelines)
- Is it really an investment? Can you regularly invest in this instrument? Can you assign a goal with these? Can you think of investing in these after retirement for regular income in mind? Are these really diversification to the portfolio when you do not know what is the rate at which you will invest and what are the risk associated with that borrower? How will you value them in your portfolio? Until unless you are in a business of lending money, I don’t think so you can own them as your assets.
So for me, it is- wait and watch at the moment.
Share your views and thinking on P2P lending in the below section.
Follow-Up Comment: Dated 17 Mar 2017, here is a news piece where SEBI says “they have not authorized any company or website to start P2P or Crowdfunding business in India”.