This column is authored by Shivasankari Bhuvaneswaran, Content Specialist, Habile
P2P lending is a relatively new kid on the block of alternative lending. Though the industry is still in a nascent stage, the p2p platforms have managed to cause their fair share of disruptions. Are these tech savvy trendsetters really a threat to the traditional lending tycoons such as NBFCs, and MFIs? Well, let’s find out!
What is P2P lending?
P2P lending is a type of new age finance offered by the people, for the people. The P2P platforms act as financial match makers between the Lenders and Borrowers by providing them an online marketplace to connect with each other and negotiate a fair deal without any financial intermediaries.
Why choose P2P?
Traditional banks don’t often take a human-centric approach. The tedious and time-consuming process of applying for a loan from bank tends to drain all energy out of the borrowers. Also, the meager interest rates offered for depositors leaves much to be desired. The millennials who are done waiting for the banks to understand them have started looking for alternative ways to lend and borrow.
The way in which P2P lending sites offer high returns for lenders while providing loans at competitive interest rate for borrowers has managed to keep the desperate consumers hooked to it.
Gone are the days where you need a perfect credit score to get your loans approved. P2P platforms ease up the nightmare of a bad credit score with their holistic approach to risk assessment.
The cutting edge machine learning algorithms used on P2P lending sites take an array of options like the net salary of a borrower, educational qualification, locality of stay, individual expenditure trends such as online spending behavior, etc. into consideration when it determines the creditworthiness of a person.
The aspect which makes a borrower eligible for a loan with a reasonable interest rate despite their bad credit history is the main reason why a steady flood of borrowers head towards P2P platforms.
Here are the major reasons why borrowers prefer P2P lending platforms:
- Easy Application Process – The hassle free process to apply for a loan from anywhere, anytime attracts affiliates.
- Lightening fast funding – Unlike traditional loans the borrowers need not wait for a long time for the loans to be approved and disbursed.
- Reasonable Interest Rates – Loan seekers are offered attractive interest rates based on their credit scores and risk factor.
The poor interest rates offered on deposits, skyrocketing real estate price, fluctuating gold value, unstable nature of stocks and the fact that P2P provides 50% bigger returns than the average deposits is the reason why a massive influx of investors (majorly Millennials) towards P2P lending.
The primary reason why investors are fond of P2P lending:
- Higher yields – The Return on Investment (ROI) entirely depends on the amount of risk an investor is willing to indulge in. The higher the risk, the better the interest.
- Empowerment – The transparent nature of P2P platforms coupled with the solid backing of risk assessment gives investors strong knowledge to control the where and how to invest.
- Diversification – Financial advisers often insist that diversification is the key to any good investment. Similarly, P2P sites offer investors an opportunity to diversify their portfolio by investing in a broad range of borrowers spread across different risk categories.
How P2P lending works
Both Lenders and Borrowers would have to fulfill certain criteria to take an active part in the P2P lending activity. The criteria may differ based on the platforms they choose. While Investors have to prove they have the money to back up the loans, the borrowers must have a decent credit score, and their monthly income should be verifiable.
Once the borrower submits a request for a loan, the lending platform assesses the application to figure out their credit-rating and evaluate the risk factor rapidly, based on which an appropriate interest rate is determined.
After the assessment, the investors could view the listings and send a proposal to the borrowers. The borrower could either accept, reject, renegotiate or send a counter-proposal. The whole process would be discreet, and the platforms never intervene in negotiation part.
Once a deal is settled, a formal contract is signed by the borrower and lender listing out the specifications of the loan such as principal, interest rate, etc.. Once the contract is signed, the funds are transferred to the borrower’s account.
RBI Guidelines – Boon or Bane?
The approach of regulators across the world is different when it comes to P2P lending. While a few countries treat them as banks and need a banking license to operate, in few countries, there are little to no regulations.
Countries like Israel which previously prohibited online lending platforms have come up with a legislation exempting the licensing requirements with a recommendation to regulate them in future.
RBI has decided to regulate the P2P space due to the impact it could have on the traditional banking channels/NBFC sector. RBI has proposed to bring P2P lending platforms across India under their regulation by defining them as NBFCs. The norms have been finalized, and the final guidelines are expected to be released in a few weeks.
- Regulating the currently nascent sector could add credibility to P2P lending, thus attracting lenders who formerly had low awareness of the industry.
- If the industry is left unregulated, we may run a risk of unhealthy practices being adopted by players, which may lead to harmful consequences. Regulation would put a stopper to such disastrous practices.
- The burgeoning industry has the potential to disrupt the financial sector altogether and drop unpleasant surprises, with a sound regulatory framework there is room to prevent such blows.
- If the regulations turn out to be rather severe, they may stifle the growth of this innovative avenue, instead of stimulating it.
- As the regulations may attract a lot of interest, lenders with little awareness of these platforms may not understand the depth of the risks involved.
NBFCs vs. P2P
Though both NBFCs and P2Ps take a vital role in shaping the financial market for the welfare of consumers, they are starkly different from each other. While NBFCs concentrate predominantly on the rural, and semi urban sectors focusing more on financial inclusion by extending out credit to the unbanked population, the P2P industry takes a pro-urban route, converging towards funding the tech-savvy individuals and business which don’t qualify for traditional loans.
Though NBFCs have a steady flow of offline customers, their lack of technology adoption made their growth rather dormant in this digital age. Though few NBFCs remain hesitant to embrace technology, a significant number of NBFCs have taken it up as a challenge and come out with flying colors.
As banks are rather wary of lending to first-time customers with little to no credit history due to the rise of bad debt issues and so NBFCs tend to focus more on this gray area. Their expertise in this arena when back by innovative technological measures would give the dominating P2P sites a fierce competition.
While P2P platforms use robust algorithms to determine the creditworthiness of a customer, NBFCs use a variety of similar innovative ways like psychometric tests, mobile apps which evaluate a borrower’s social media profiles, etc.. to ascertain a borrower’s behavior as a part of risk assessment.
NBFCs have the edge over P2P sites when it comes to procuring customers since they rely on the most powerful marketing strategy, the “word-of-mouth” marketing. Most NBFCs either depend on traditional financial organisations such as public/private sector banks or attempt to raise funds through bond market forms, not many NBFCs opt for public funding.
On the other hand, P2P sites depend completely on individual investors. They already have a hard time educating the masses about this new asset class and helping them understand the intricacies involved. The unregulated nature of P2P landscape makes investors look at it through a thin veil of skepticism tinted perception. Spreading awareness amidst this suspicion to attract borrowers and lenders is the most challenging factor faced by the P2P sites.
The revenue model of NBFCs and P2P platforms are almost similar. NBFCs acquire funds from various source and lend those funds to individuals or business at a higher rate. Here, the revenue generated is just the lending rate (aka portfolio yield).
Similarly, P2P platforms generate revenue charging borrowers a flat rate or a negligible percentage of the loan value as the transaction fee or commission charge. Some platforms also charge investors on the returns they generate.
Likewise, just because the P2P platforms garners attracts a large volume the techno-dexterous population doesn’t mean that NBFCs have to look at them as threats. Technology is the primary driving force in today’s world, so as to cement their presence as an alternative to traditional banking, NBFCs have to embrace the technology led innovation which is disrupting the Financial sector.
Instead of looking at P2P sites as competitors, NBFCs could make a tie-up with them to create a strong business model which leverages technology to come up with an innovative customer-centric product that is tailor made to fit their specific needs.
“NBFCs are seasoned veterans when it comes down to lending, fusing their expertise with the tech savviness of the P2P sites could cause the financial landscape to flourish and grow exponentially.”