Home » What is peer-to-peer lending, how it works, and the pros and cons?

What is peer-to-peer lending, how it works, and the pros and cons?

Photo courtesy Mohamed Hassan Pixabay.

Peer-to-peer lending connects borrowers to the lenders or groups of lenders. There are platforms for peer-to-peer (P2P) lending and it is an alternative to fixed deposits that nowadays give a very low rate of interest. Lenders can earn interest much higher than a savings bank account and borrowers can get funds at rates equal to or more than banks. Since these are unsecured loans the interest rates are higher than banks or NBFCs.

The online Peer-to-peer platform is easy to use, and offers the choice to both the lenders and borrowers, and helps in matching lenders to borrowers. The lending process is safe if you lend through an RBI-certified NBFC. This model is based on crowdfunding and helps in meeting the business and other requirements of persons. P2P platforms are like NBFC fintech companies and conduct an auction where a lender can bid for a borrower’s loan requirements and the borrower can either accept or reject the offer.

Peer-to-Peer lending in India-

The Reserve Bank of India had registered 21 NBFCs to run the peer-to-peer lending platforms as of May 2021, with Mumbai alone having nine such companies. Some of the P2P lending platforms in India are; Faircent, Lendenclub, Finzay, OMLP2P, Cashkumar, i2ifunding, Lendbox, and Rupeecircle.

The lenders help the borrowers to get their requirements funded at viable rates and in turn get a good return on the amount they lend. The visitors to the site can register as lenders or borrowers. The platform does the verification of both the lenders and the borrowers based on personal, financial, and professional information provided.

The lenders who join a platform have to complete the registration process, pay the registration fees and provide the required documents. After completion of verification, the lender can pre-fund his account with the amount he wishes to lend and can start lending by sending proposals to borrowers. There are details of the borrowers provided on the lender’s dashboard and he can arrive at a decision and send a proposal to the borrower. Loan disbursal can begin only after a loan agreement has been signed. The borrower provides post-dated cheques as security and the lender receives EMIs by a certain date of every month. If the borrower defaults on payment within the time he is charged a penalty which is paid to the lender.

The borrowers have to follow a registration process, pay the registration fee, and submit the required documents which are then verified. The borrower’s identity is verified, a risk assessment is done and the system shows if the borrower will be able to repay the loan efficiently. The team will approve the account after verification most likely within 1 day. The loan tenure is from 6 months to 36 months and the rate of interest varies from 10% to 36%. A borrower has to make the EMI payment by a fixed date and if he fails a penalty is charged for every delayed payment. The interest rates are determined by a P2P player by evaluating borrowers’ profiles and credit history.

Once an agreement is reached between the lender and the borrower a legally binding contract is signed online and the loan amount is transferred to the borrowers’ account. Repayment can be done online and an online agreement is available to both the borrower and the lender. The processing fee charged from a borrower is 3 to 5 percent and a percent from the lender by the platform.

 Advantages of P2P lending-

The returns by P2P lending give a better return than saving bank account or the fixed deposits.

Approval of a loan from a P2P lender is quick and after you register on the website you get connected to the lenders.

Documentation is minimal as compared to the documentation of the banks; this being due to the sites being tech-savvy. The processing is fast and the borrowers need not wait for a long time for the loan to get approved and disbursed.

The banks and financial institutions do not provide loans to borrowers with poor credit scores. In the P2P system, the lender decides whom he wants to give the loan.

Low-income group people can get loans in this way as they can negotiate directly with the lenders and sometimes can get loans at better rates than banks.

The P2P platform teams carry risk assessment; thoroughly vetting the borrowers.

A person can lend to many borrowers and distribute his risk.

The minimum lending amount can be quite low and a person can start lending easily.

The P2P platforms are regulated by the RBI.

Risks associated with P2P lending-

The borrower may default on the payment. This could be due to the borrower’s credit profile deteriorating after borrowing from several borrowers.

The online lender can be conned when people submit loan applications with fake identities and create a profile for borrowing. So it is better to go through RBI-regulated P2P players.

Lending a high amount to a single borrower is risky. This can be overcome by lending to several borrowers.

RBI regulates the P2P lending platforms-

The RBI regulates the P2P lending platforms for protecting the interests of the borrowers and the lenders. It has made it mandatory for the existing P2P companies to apply for a license and continue their operation as a P2P platform.

The RBI has asked the P2P platforms to implement information security measures which are then audited by an external party where the faults in the system are identified and contingency plans built for every situation.

The RBI guidelines for the P2P platforms are-

A lender can lend a maximum of Rs. 50 lakhs across all P2P platforms at any given time.

The lender must provide proof of net worth if lending more than Rs. 10 lakhs across all P2P platforms.

Borrowers can take a maximum loan of up to Rs. 10 lakh across all P2P platforms.

The lending platform can’t offer guarantees on the loan.

A single lender can’t lend more than Rs. 50,000 to a particular borrower.

The company should be incorporated in India and should have technological and managerial resources to act as a P2P lender.

The company should have an adequate capital structure and management.

The company should be granted a Certificate of registration by the RBI to serve the public.

The maturity of loans shall not exceed 36 months.

Steps to follow if you want to carry out peer-to-peer lending –

Study the history of the company with which you want to work and find out how much percentage is the default rate. What were the returns produced in the past and how they handled late payments?

If you are lending for the first time it is better to lend a small amount which will give you time to understand the platform and prevent you from making big mistakes.

Everything boils down to how much risk you wish to take and how much you are ready to lose if a borrower defaults. Lower-grade investments carry higher rewards but there is a high risk of lending to a low-grade borrower.

Your money should be distributed among many loans to minimize the risk of defaults. This way your profits will be higher than the defaults you will face.

If you want to lend to lots of people it might become difficult to track them. Utilize automation and let the lending platform help you.

Never take more risk than you can handle.

P2P loans are unsecured and the platform should disclose on its website the method of credit assessment, the grievance redressal mechanism, business model, and details of the grievance redressal officer. The platform should carry out due diligence of its participants, the credit assessment and risk profiling of the borrowers, and disclose the details to the lenders. The P2P platform also assists in the disbursement and recovery of loans. It should maintain two escrow accounts; one for receiving funds from lenders and the other for collecting from borrowers. It should also disclose the identity of the lender to the borrower.

Before joining a portal online it is advisable to check the reviews and ratings of the website as you will be sharing personal and professional information. Borrowers can visit many websites and check which provides them the best interest and bargain to their maximum benefits. The things to be checked along with the EMI are the loan tenure, processing fee, and any other hidden cost for which the terms and conditions may have to be referred to. The peer-to-peer platforms benefit both the lenders as they get a higher rate of interest than the bank rates and the borrowers as they can get loans with a lower credit score as compared to the banks.

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