India is blessed with a young population and a middle class that continues to aspire to rise further. However, these high aspirations need fuel in the form of funding and individuals are turning to loans to invest in their future through education, homes and much more. The fast paced expansion of various loan segments in India has of course caught the eye of lenders and almost every bank and NBFC in India is engaged in providing a huge bouquet of loans to cater to the requirements of individuals from almost every walk of life.
Unfortunately, not everyone qualifies for a loan offered by an Indian bank or NBFC and this is especially true in case of self employed persons whose income may be seasonal or substantially affected by various market factors. Additionally, with banks and NBFCs placing major emphasis on a Credit Report check as part of their loan application process, those with low credit score, no previous credit history and others who do not fit into a standardised category can also find it hard to get a loan. This is where peer to peer lending comes into the picture.
Peer to Peer Lending: An Overview
Peer to Peer lending, popularly referred to as P2P lending, enables individuals to lend/borrow money from other individuals without having to depend on standard banking channels. P2P lending is in fact a type of crowd funding that matches the needs of borrows and lenders. The most popular method through which such individuals can seek each other out is by enrolling into a P2P lending platform and the popularity of this form of lending/borrowing has seen significant growth over the past couple of years. Consider this, in 2015 alone, 20 new online P2P lending companies set up shop in India and as of April 2016, 30 such lenders were operating in India.
How Does P2P Lending Work?
The prospective lenders and borrowers have to sign up on the P2P lending platform and become a member in order to participate in the process. Before allowing you to borrow or lend money, the P2P lender would perform a range of checks regarding employment, credit history, the purpose of the loan, etc. Though these checks might seem similar to those performed by a banking institution, the P2P lending norms are quite a bit more flexible.
Depending upon the results of these checks, borrowers are assigned different categories according to their perceived risk of default. For the borrower, the higher the perceived risk, the higher the interest rate charged on P2P loans provided to them. Similarly, the interest rates charged are lower in case of borrowers who are perceived to pose a lower risk of default. The prospective borrower has the option of either selecting a loan from the assigned risk category and pay a pre-determined rate of interest or he/she can have prospective lenders bid on the suitable rate of interest. As with other crowd-funding initiatives, it is not unusual to have multiple lenders pooling their resources to provide a loan to a single large borrower.
Lenders who sign up for the service also have to undergo checks to ensure that the money they are providing as a loan has not been obtained through illegal activities. Once a lender signs up for a P2P lending service, the choices are simple – bid on available loans or allow the P2P platform to distribute your funds among multiple borrowers with different risk profiles in order to balance your risks and increase your potential returns.
The Benefits of Peer to Peer Lending
- The primary benefit of P2P lending is the fact that this platform potentially provides loans to individuals who do not fit into the lending criteria prescribed by the traditional lending institutions.
- Lenders too can benefit from higher rates of return offered on the money they provide as loans to the P2P borrowers.
- This is also an ideal transaction platform for borrowers and lender who prefer to negotiate rates rather than having middlemen negotiating on their behalf.
- The P2P lending process can be quite streamlined with faster loan processing times.
- In case of most P2P lenders, there is no pre-payment penalty, which further increases the flexibility of these loans.
Reserve Bank of India and the future of Indian P2P Lending
Till very recently, the growing segment of P2P lending seems to have gone relatively unnoticed in India. However, recently, the Reserve Bank of India has published a paper suggesting that this nascent financial segment be regulated and P2P lenders be classified as a new class of Non Banking Financial Companies (NBFCs). This action, if it comes to fruition would provide much needed legitimacy to the P2P lending segment. Some P2P players have even voiced intentions of introducing a Nodal Agency in order to help them keep track of the amount of funds flowing through the system at any given time.
Additionally, the growing popularity of this type of financing has also led Indian NBFCs to take note and some of them have already initiated processes to tie up with P2P lenders in order to acquire new customers. The main benefit to NBFCs as a result of such tie ups is the decreased cost of credit verification which would improve the profits of these companies and also allow them to expand their business into untapped segments of Indian society. From the loan applicant’s point of view, their choice of probable lenders would increase and this could potentially bring down their cost of borrowing.
The fact that RBI has proposed regulations on P2P lending activities is in fact a sign that the central bank sees P2P lending as an emerging segment instead of being a threat to traditional banking channels. Going forward, we can expect the peer to peer lending space to undergo further changes to further streamline the loan application process. Some of the suggested improvements include direct transfer of loan from lender account to borrower account for prevention of money laundering and implementation of ECS-based debit systems for timely loan repayment.