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Why P2P lending is not like FD investing

The concept of peer-to-peer (P2P) lending is not new to Indians. We have seen our parents lending to people around us for say, health related emergency, for assisting them financially in their business etc. While this used to be an unorganised practice, platforms such as Faircent, LenDenClub, and Cred Mint attempt to enable the same in a more organised and structured manner. Looking at the interest rates of as high as 14-18 per cent, many feel P2P lending is quite attractive compared to fixed deposits and even mutual funds. However, before getting lured by the rates, you should know a few things about P2P lending.

How does P2P lending work?

Peer to peer lending is an alternative way of financing that allows individuals and businesses to borrow money directly from individuals through digital platforms without the involvement of any financial intermediary. Borrowers and lenders need to get themselves registered on such platforms, for which registration fees are charged in the range of ₹ 100-750. Borrowers are then evaluated by the platforms based on their creditworthiness and placed in different risk baskets. Loans given are charged high interest rates, as they are not secured.

What are the regulations?

The P2P lending platforms are regulated and treated as NBFC P2P by the Reserve Bank of India (RBI). First, the company running the P2P platform must have net owned funds of minimum ₹ 2 crore.   A total lending cap of ₹ 50 lakh is set by the RBI for total exposure across all platforms. Also, the total amount that one can lend is based on his/her own net worth. Typically, you’ll have to produce a certificate on the respective P2P platform stating that your net worth is more than ₹ 50 lakh as certified by a practicing Chartered Accountant if you wish to lend more than ₹ 10 lakh. Further, you can’t have an exposure of more than ₹ 50,000 to a single borrower and maximum tenure for which you can lend is three years.

Who are the typical borrowers in such platforms?

The P2P lending platforms often say they follow stringent credit assessment procedures for borrowers based on their income, repayment history, financial stability, and credit score and that they have a very high rejection rate. However, one must note that there are very high chances that the one whom you’re planning to lend on these platforms might have come to to such platform due difficulties in availing loans from traditional financial sources such as banks and NBFCs (Non-banking financial companies). This may be because of a weak credit profile or absence of any credit history. Due to the very same reason, they carry high default risk and are ready to pay interest rates as high as 14-16 per cent and even beyond 20 per cent in certain cases. Hence, one should not simply rely on the platforms’ methodology of risk assessment.

Default handling methods

P2P platforms put in place various checks and balances to minimise default rates such as auto debit options to recover EMIs, personal visits through agencies, follow-up mails, maintaining escrow account and collection of pre-dated cheques. Even after this, there still remain chances of payment delays and defaults, following which these platforms take steps such as serving legal notice to the defaulter, using security cheque to recover amount or filing case under Negotiable Instruments Act in case the cheque is dishonoured. Despite all such practices, there is no guarantee that the principal amount will be fully recovered.

Should you go for it?

One needs to understand that P2P lending is just meant to help those who are in dire need of funds by lending them temporarily and earn interest. It should not be considered as an investment product giving high returns and hence shouldn’t be compared with fixed deposits and mutual funds. Even if a bank defaults, one is quite sure that he/she will be able to recover the funds to the tune of ₹ 5 lakhs as all scheduled commercial banks are covered under the deposit insurance scheme of the DICGC. However, there is no such thing for P2P lending and hence once default happens it becomes very difficult to recover the principal from the borrower. Do note that this space is still at a nascent stage in India, we have in front of us the example of China where Chinese Banking Regulatory Commission had to step in and put stringent regulations in an otherwise unregulated business owing to high default rates.

Hence a retail investor even with a surplus amount of money should avoid entering into P2P lending and can look at mutual funds, debt funds and fixed deposits at small finance banks for attractive returns.

Published on August 27, 2022