Reserve Bank regulations for P2P lending platforms

This January and February RupeeCircle and Lendbox respectively kick-started the latest financial innovation in the country, Peer to Peer (P2P) lending after their Reserve Bank of India (RBI) certification as Non-Banking Financial Companies (NBFCs)-P2P. Under NBFC-P2P, the P2P platforms are required to conduct their business in accordance with the October 2017 RBI guidelines. These regulations would build the credibility of these platforms for lenders and borrowers alike.

The concept of P2P lending is to provide a virtual marketplace for borrowers and investors to interact directly with each other without the intervention of traditional financial intermediaries like banks. Originally, P2P lending connected individual lenders and borrowers on a one-to-one basis. Over time, it emerged as a marketplace where individuals and institutional investors lend into a pool of funds that borrowers can access. Investors look for higher returns within their risk appetite and on other side, lenders look for low-interest rate, simplified application process and quick disbursal of loans.

The first P2P Company Zopa was born in the UK, in 2005 whereas the US adopted the same business model in 2006 with a clutch of companies named Lending Club and Prosper. In 2012, India got its first P2P platform, I-Lend and by 2016, the number rose to 30 P2P platforms.

Primarily, a borrower registers on the platform after fulfilling their credentials to apply for a loan. Then the platform evaluates the borrowers’ documents and credit history to generate risk and credit rating report and provide various options for interest rates on the basis of an available investor. The applicant chooses a suitable option and loan application appears on the platform. The investor takes the final decision to lend on the basis of various aspects like a credit report, expectation from investment, the risk involved etc. The platforms fix interest rates or by mutual agreement between the involved parties. After the loan is sanctioned, the borrower is responsible for interest and principal payment according to agreed terms. P2P platforms charge a fee from both the parties to provide services, depending on the terms of the platform. For instance, i2i Funding charges Rs 100 and Rs 500 as registration fee from borrowers and lenders, respectively. The platforms provide an opportunity for borrowers who are unable to fulfill the collateral requirement of the banks.

On the flipside, P2P lending is generally involved in unsecured loans, with no collateral to back any payment default in future. Secondly, the money invested is not insured by the government, unlike normal savings. Therefore, a lender should be aware of the credit risk. Lastly, Peer-to-Peer platforms do not provide any medium-term and long-term loans. Despite these shortcomings, P2P lending has recorded a Compound Annual Growth Rate (CAGR) of 123% globally from 2010 to 2014. According to the RBI report, P2P lending is expected to reach US$ 1 trillion in 2025 with a CAGR of 60%.

Whenever a government introduces financial regulations, it has three major objectives: to protect the consumer, to sustain systemic stability and to maintain the safety of financial institutions. In the case of systemic risk, P2P platforms are less significant than banks as they do not take positions in loans, they just match the risk appetite of lenders with the risk profile of borrowers. The industry has the potential to disrupt the traditional banking channels/ NBFC sector which will further affect the stability of financial institutions. So, it is important to acknowledge this source of finance. Consumer protection from the risk of unhealthy practices adopted by any player is necessary. Default by any party can affect the entire P2P industry at large. Therefore, Reserve Bank of India (RBI) issued a Master Directions- Non-Banking Financial Company- Peer to Peer Lending Platform Directions, 2017 in October 2017 which provide detailed guidelines that all existing and new entities will need to adhere to conduct their businesses.

The Master Directions introduced the scope of activities (Dos and Dont’s) for P2P platforms. The platforms can act as an intermediary only, which ensures that all the legal requirements should adhere and proper due diligence of a participant. It is mandatory for platforms to perform credit assessment and risk profiling of the borrower, and disclosure of the same to prospective lenders. Platforms need to submit their quarterly financial reports within 15 days of the next quarter, with the relevant information. The platforms are required to put adequate risk management systems for data privacy. Also, RBI regulations prohibit P2P companies to lend or to raise deposits or cross-sell any product (except loan specific insurance products) on its platform. They are not allowed to provide any credit guarantee and facilitate secured loans. P2P lending platforms are prohibited from access to the international flow of funds. These are the major guidelines that P2P lending platforms need to adhere to.

With the growing automation and innovation in financial services, P2P is growing at a faster speed. The regulations have given a new lease of life to the P2P lending industry in India. It will be interesting to see whether it will prove to be a new beginning or not.

(Latha is an Associate Professor of Finance and Yashika is Scholar of Finance with the Institute of Management, CHRIST Deemed to be University)