We often borrow money from family members or friends instead of banks or NBFCs. This borrowed amount can be used to cover medical expenses, business investments or any kind of personal emergencies. However, in such a scenario, mutual trust and personal connection play a key role in deciding whether you can take a loan.
Peer-to-Peer (P2P) lending exhibits a similar investment pattern. However, they take place on an online platform. The following sections will cover P2P lending in more detail.
What Is P2P Lending?
Peer-to-Peer lending, or P2P lending, is much like crowdfunding or crowdsourcing. However, under this system, borrowers request funds directly from other individuals instead of financial institutions.
Potential lenders and borrowers need to register in a P2P platform where they can lend or borrow funds. Borrowers can receive money from these websites without having to go through traditional banking procedures, which reduces the time required and complexity of getting funds.
How Does P2P Lending Work?
P2P lending occurs in a decentralised online platform which matches lenders with borrowers. This platform eliminates the role of banks and other financial institutions in the borrowing process.
Like every financial platform, one must undergo simple verification to register in P2P lending platforms. Then, interested borrowers must submit an application form on this website. The application form is very much like any loan application form for banks.
After this, the platform’s staff will perform verification on the data of a borrower’s identity, employment, and credit history. They also assess the risk a lender would take to offer a loan and set an interest rate accordingly.
Finally, these P2P platforms may do deeper research on applicants’ credit profiles by checking their social media activities and most used apps. With all this information, they prepare a loan application published on the website. This helps lenders make a more informed decision.
Lenders present on this platform browse through these applications and choose borrowers they are willing to lend money. After they provide the full funding of a loan, the P2P website will transfer funds from lenders to borrowers after deducting an upfront fee. This process can be entirely automated, or the interested parties can choose to negotiate.
Borrowers can also browse this platform for suitable lenders and reach out to them to sanction their loans. They can either request one lender for an entire amount or opt for multiple options.
RBI strictly monitors these platforms to avoid any fraudulent activity here. For instance, RBI can penalise a P2P platform if it holds on to the money provided by lenders. Moreover, these platforms have to get an NBFC-P2P licence from the central bank.
What Is the Importance of P2P Lending?
From a borrower’s perspective, opting for bank loans is tedious. First, it involves choosing the right bank that suits your loan criteria. Furthermore, you must fill out several applications, undergo verification processes, sign papers and wait for your loan approval.
However, peer-to-peer lending eases the lending and borrowing process. A P2P platform is like a marketplace where borrowers can find an array of lenders to fund their needs. The importance of P2P lending is given below.
- These platforms eliminate the hassles involved with the loan sanctioning process of traditional modes.
- P2P platforms directly connect lenders and borrowers after registration and successful verification. This process takes very little time as compared to traditional modes.
- One does not need to worry about frauds with P2P lending as RBI monitors these platforms. However, this risk can not be eliminated.
- Peer-to-peer lending platforms help extend credit to individuals who cannot acquire loans from banks. This can include people with low credit scores.
- Lenders can choose to provide P2P loans to gain better returns on their investments than from bank deposits and other traditional investments.
Examples of P2P Lending Sites
Following are a few peer-to-peer lending platforms that are popular in India:
- Lend Box
- Rupaiya Exchange
What Are the Benefits of P2P Lending?
As we get a deeper insight into P2P lending, here are some benefits of peer-to-peer lending for both investors and borrowers.
- Potential for higher returns: P2P lenders may be able to earn higher returns on their investments compared to traditional financial products, such as certificates of deposit or money market accounts.
- Access to credit: P2P lending can provide borrowers with access to credit who may not qualify for a traditional loan. This can be particularly beneficial for individuals with limited credit histories or those who have been turned down for loans from traditional lenders.
- Flexibility: P2P loans can be tailored to meet the specific needs of both lenders and borrowers. For example, lenders may be able to choose the duration of their investments and the interest rates they are willing to accept, while borrowers may be able to choose the terms of their loans.
- Lower fees: P2P lending platforms often charge lower fees than traditional financial institutions, which can make borrowing or lending through these platforms more affordable.
- Convenience: P2P lending platforms can be accessed online, which makes it easy for lenders and borrowers to connect and complete transactions.
What Are the Drawbacks of P2P Lending?
Peer-to-peer (P2P) lending is a way for individuals to lend and borrow money without going through a traditional financial institution such as a bank. While P2P lending can offer some benefits, such as the potential for higher returns for lenders and access to credit for borrowers, it also carries some risks and potential drawbacks. Here are a few:
- Default risk: One of the main risks associated with P2P lending is the possibility that borrowers will default on their loans. When this happens, lenders may not be able to recoup their investments, which can lead to financial losses.
- Lack of regulation: P2P lending is a relatively new industry and is not subject to the same level of regulation as traditional financial institutions. This means that lenders and borrowers may not have the same level of protection as they would with a bank or credit union.
- Limited borrower information: P2P lending platforms may not provide lenders with as much information about potential borrowers as traditional lenders do. This can make it harder for lenders to assess the risk of a potential investment.
- Limited liquidity: P2P loans are typically not as liquid as other investments, such as stocks or mutual funds. This means that lenders may not be able to sell their investments as easily or quickly as they might be able to with other assets.
- Lack of diversification: P2P lending can be a relatively concentrated investment, as lenders may be lending to a small number of borrowers. This can increase the risk of financial loss if one or more of these borrowers default on their loans.
Things to Keep in Mind When Using P2P Platforms
While investing or borrowing on a P2P platform, one must remember the following points.
- Borrowers must carefully read the eligibility criteria of the P2P lending platform before applying for a loan. This will help them know whether they are eligible for listing on the P2P platform or not.
It is also a good idea to check for locations the P2P platform covers, maximum and minimum loan amounts and applicants they prefer. You will find all these details in the eligibility criteria of P2P portals.
- You must also check for upper limits for your loan amount. Many P2P lenders set a certain upper limit even though RBI mandates a limit of Rs. 10 lakh for a single person. This information comes in handy for individuals seeking a higher loan limit.
- As an investor, you should start with baby steps to stay in this game for a longer time. For instance, depending on your risk appetite, you can begin lending around Rs. 50,000 to Rs. 2 lakh in these loans. By starting with small investments, you can slowly grow your loan portfolio organically and steadily.
- Although P2P platforms help you manage a large number of borrowers, as an investor, you must know where to stop. You must be aware of risks before investing in a huge number of borrowers.
- Spreading your investment across several creditworthy borrowers will help you diversify your portfolio. To do so, you can opt for different profiles based on gender, occupation, risk and location while investing.
- To avoid being a victim of scams, check whether the website is registered as NBFC-P2P under RBI. NBFC-P2P lending platforms must abide by regulations and norms set by RBI. Thus, they are safer options to invest and borrow.
- Before borrowing money, confirm whether there are any additional charges on your loan. Experts suggest that a borrower must consider all forms of additional charges while calculating their EMI. This shall help the borrower to make an informed financial decision.
Growth of P2P Lending in India
With the eventual growth of start-ups and entrepreneurship, one can notice the popularity of P2P loans in India. Yet, at its initial stage, the P2P lending industry has caught the attention of the RBI for its inherent potential to rule the market in days to come.
Unlike banks and other NBFCs, P2P lending platforms opt for more innovative and unconventional means to verify data and users. As stated, P2P lending platforms seek information from applicants’ social media for verification.
This new technology was first introduced in 2012 and was welcomed with great enthusiasm. As a large number of investors and borrowers stood to benefit from P2P Lending, it further encouraged the growth of several P2P platforms.
With NBFC-Peer to Peer Lending Platform (Reserve Bank) Directions, 2017, RBI introduced some essential regulations to monitor P2P lending platforms. To maintain sustenance, RBI mandated this Master Direction to regulate several factors like the registration process, leverage ratio, and an escrow account.
P2P loans are like instant personal loans as they require a very simple application process and are disbursed instantly. While borrowers get instant access to loans that they could not get from traditional lenders, lenders get to collect fixed interests at a relatively high rate. This is why P2P lending has become so popular amongst both borrowers and lenders. However you should understand the risks involved in this mode before lending or borrowing
Frequently Asked Questions
What taxes are applicable on P2P lending?
Just like fixed deposits, interest earned from P2P loans is taxable. However, P2P lending falls in the category of income from other sources and is taxable as per the tax slab of the investor. Thus, if a P2P investor belongs to the 30% tax slab, then he/she is liable to pay a 30% income tax on profits earned from P2P lending.
Is P2P lending safe for lenders?
The process of lending and borrowing money for peer-to-peer lending is relatively risky as the investor is completely dependent on the credit evaluation of the P2P platform. it carries considerable risks, even higher than some equity investments. Although there are no market-linked risks, there is a high risk of default. When this happens, there is no guarantee of recovery of money.
Do P2P platforms charge any fee from lenders?
Some P2P platforms charge registration fees from lenders. They also charge a transaction fee of 1-2% from lenders. P2P platforms generally deduct this amount from the first EMI that the borrower pays. There may also be a processing fee of around 2-8% for borrowers, depending on the loan applicant’s risk profile.
Anuj is an investment professional with a demonstrated history of working in Debt Capital Markets. He has completed his B.Com (Hons) in St. Xavier’s College, Kolkata and holds PGDM (Finance) degree from GIM. He is currently working as Investments Principal at Wint Wealth. He has been working in the debt capital market space for the past 4+ years and is also an NISM certified mutual fund expert.