Smart Lending

By: Akmal Khan

P2P lending is emerging as an attractive investment option in the debt segment promising 15-20 per cent returns

If you have money to invest for the short term, you can consider a new option in the debt segment other than traditional debt instruments such as debentures and bonds – peer-to-peer (P2P) lending, which has emerged as an attractive avenue for people who don’t mind taking some additional risks for extra returns. This involves lending money to individuals or businesses through online services that match lenders with borrowers. Recently, even the Reserve Bank of India (RBI) showed confidence in the fledgling segment by revising a lender’s exposure limit across P2P platforms from Rs 10 lakh to Rs 50 lakh. Experts say one can earn good returns by diversifying risks across types of borrowers.

Key Regulatory Developments

P2P players have been in existence since 2012, when the first platform – i-Lend – was launched. Initially, there was hardly any regulatory oversight. Seeing the potential of the evolving technology and growth of lending to the underserved, the RBI came out with guidelines in September 2017, to convert P2P players into NBFCs by issuing NBFC-P2P licences. There are around 30 P2P players in the country of which 20 had got the NBFC-P2P licences as on October 31, 2019; the rest have applied for it.

One can invest up to Rs 50 lakh across P2P platforms. The minimum amount is Rs 25,000. The RBI has specified that the tenure of a single loan cannot be more than three years. Exposure to a single borrower cannot go above Rs 50,000. For example, if you have Rs 50 lakh to invest, you need 100 borrowers across platforms. “This is good because it ensures better diversification. On our platform, we have fixed it at Rs 20,000,” says Ajit Kumar, Founder & CEO, RupeeCircle.

How It Works

P2P platforms work as a conduit to connect borrowers with lenders. The borrowers could be individuals or micro, small and medium enterprises. “Lenders on P2P platforms act like banks to earn returns on their surplus funds by lending directly to pre-verified borrowers,” says Rajat Gandhi, Founder & CEO, Faircent, India’s first P2P player to receive the RBI’s NBFC-P2P licence. Once the amount is invested and disbursed to borrowers, you receive repayments either on monthly or quarterly basis.

P2P platforms use innovative ways to assess the creditworthiness of borrowers by using both traditional KYC data and digital footprints. Faircent claims to have an automated underwriting mechanism that does a comprehensive risk analysis covering 120-plus parameters. As a lender, you can check the profiles of all borrowers with details of their age, marital status, housing status, employment, education, other liabilities, average quarterly bank balance and expenditure-to-income ratio to make an informed investment choice. However, P2P lending is still at a nascent stage and the credit assessment process is not time-tested yet. So, it will take time for these players to build a credible track record of risk management.

The Risks

The only risk in P2P lending is credit default by borrowers. It is similar to the risk involved in fixed income instruments such as NCD (Non-Convertible Debentures) and CPs (Commercial Papers), says Bhavin Patel, CEO & Co-founder, LenDenClub. To minimise the default risk, one should diversify investments and lend small amounts to multiple borrowers.

“To diversify, investors can use the 80:20 formula, that is: lending 80 per cent to high-rated clients with reasonable returns and 20 per cent to low-rated clients. Diversify maximum while lending to lower-rated clients,” says Rajan Pathak, Founder & MD, Adapt Fintech Advisors.

If a default happens, most P2P players have an in-house collection and verification team to collect missed payments on behalf of lenders. The default rates at LendenClub, RupeeCircle and Faircent are 4.2 per cent, less than 1 per cent and around 2 per cent, respectively, as per data from the companies.

P2P lending is regulated by the RBI

  • The interest rate charged varies with the perceived risk and credit score
  • Returns are less volatile than in products such as equities, commodities
  • Innovative credit assessment tools are used to judge the risk profile of borrowers
  • You are free to choose the borrower matching your return and risk parameters
  • If a borrower defaults, you bear the losses, not the P2P platform; but the P2P player may help in recovery
  • A good strategy is to diversify across different types of borrowers

The Edge

While any instrument offering double-digit returns will be risky, the advantage with P2P is that the returns are not volatile. “Unlike traditional investments such as equities, commodity and forex, there is zero volatility in P2P lending as these investments are not market-linked,” says Patel of LenDenClub. He also points out that lenders must understand the difference between return on investment (RoI) and net returns. “RoI is the rate offered to borrowers after considering credit default risk to derive net returns expected by the lender,” he explains. The difference between RoI and net returns is what the P2P platforms earn.

Should You Invest?

Looking at the high double-digit returns that these investments have earned, investors with risk appetite should consider adding P2P lending in their portfolio. But start with small amounts and short durations. Kohli of Client Associates says one can start investing with a six-month period before increasing it to 12 months and more. Rajan Pathak, Founder & MD, Adapt Fintech Advisors, agrees. “Lenders should start with a tenure of one year with a small amount, opting for the quarterly interest payout option. Keep an eye on refund capability of borrowers and reset the horizon and investment amount after a year based on experience.” Pathak says one should select the P2P platform on three parameters: Borrowers’ on-boarding process, recovery mechanism and robustness of the player.

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