Essay, Pages 13 (3120 words)
The mainstream financial system imploded after the collapse of the financial system in 2008 and digitalization after demonetization, India left millions of borrowers an extraordinary debt burden and individuals and small businesses cut off from fresh sources of credit. The volatility in the stock markets, low rates in most categories of bonds and devaluation of Indian currency popularized the term disintermediation and prompted more investors to turn to a cashless financial system and nonconventional sources funding. In this growing global market getting in touch with potential investors and borrowers is challenging and this is where this digitalization and green banking system come in with their technology enabling them to operate more efficiently and at cost advantage than the traditional banking system.
Globally, Markets like the USA and the UK have adopted the concept of peer-to-peer lending and numerous financial organizations are successfully operating in that space. In India the concept is new, but lending market is huge and there is great potential for the concept of peer-to-peer loans to be a success.
Several online portals have sprung up in India to facilitate such lending, especially after demonetisation and some even getting private funding from investors, but it is still at a nascent stage compared with countries such as the US and China. Reserve Bank of India first brought out a discussion paper on peer-to-peer lending in April 2016, it said that there were 30 such start-ups in the country. It then proceeded to fashion a set of rules for the nascent but fast-growing sector and came out with regulations in October 2017 and this study aims to analyse the mode and operations of the nonconventional lending p2p system for the investors and borrowers
Keywords: Nonconventional sources of finance, peer to peer lending, digitalization.
Indian economy is characterised by a very strong financial system. For a serene and stable functioning of any financial maket a strong capital base and financial inclusion in all fields is very necessary. The Government of India and RBI have taken considerable steps in the last few years to achieve financial inclusion. The Jan Dhan Yojana, the Digital India initiative, launch of payments banks and small finance banks have contribute in improving the attain of formal financial services to hitherto unbanked populace and areas.
However, there is still a extensive way to go when it comes to access to credit from formal channels. The share of unorganized lending in India remains extremely high. The latest CRISIL Inclusive report 2016 states that a major part of the country’s population does not have access to credit services from banks or microfinance institutions. Only 20 crore borrowers have loans from institutions, which is radically lower than the number of deposit accounts. Common sources of business capital include loans from friends and relatives, personal savings, loans from financial institutions such as banks or credit unions, assistance from venture capital firms or investment clubs, loans from the Small Business Administration and other government agencies, loans from commercial finance companies and personal or corporate credit cards.
But after the global financial crisis and digitalisation investor appetite for alternative sources of yield, big data and enhanced analytics, faster response times, quicker loan approval times and faster funding are few factors that lined the way for innovations in credit platform. In such instances, the capital-hungry entrepreneur has the choice of pursuing a number of non-traditional financing sources to secure the money that his or her company needs. Some of the more common non-traditional financing sources include, borrowing against the cash value of a life insurance policy selling assets, and taking out a second mortgage on a home or other property. The financial sector is not immune from the initiation of online industry and its potential impact. For this reason, it is attracting attention of analysts, customers, businesses, investors and regulators in a major way. Peer-to-Peer (P2P) lending the method of debt financing that enables individuals to borrow and lend money – without the use of an official financial institution as an intermediary and removes the middleman from the process is such a business model that gathers momentum globally and taking roots in India
- To study the mode and operation of p2p lending system
- To study the benefits and drawbacks of p2p lending system
Source of Data
To study about the peer to peer lending system, secondary data is collected from the journals and from the reports published by RBI about the non conventional lending systems. The growth of p2p lending in India, its benefits and drawbacks are collected from some p2p online sites.
Peer-to-Peer Lending (P2P Lending)
P2P lending is a form of crowd-funding used to raise loans which are paid back with interest. It can be defined as the use of an online platform that matches lenders with borrowers in order to provide unsecured loans. The borrower can either be an individual or a legal person requiring a loan. The interest rate may be set by the platform or by mutual agreement between the borrower and the lender. Fees are paid to the platform by both the lender as well as the borrower. The borrowers pay an origination fee according to their risk category. The lenders, depending on the terms of the platform, have to pay an administration fee and an additional fee if they prefer to use any additional service (e.g. legal advice etc.), which the service may provide. The platform offer the service of collecting loan repayments and doing preliminary assessment on the borrower’s creditworthiness. The fees go towards the cost of these services as well as the general business costs. The platforms do the credit scoring and make a profit from arrangement fees and not from the spread between lending and deposit rates as is the case with normal financial intermediation. While crowd funding – equity, debt based and fund based- would fall under the purview of capital markets regulator (SEBI), P2P lending would fall within the domain of the Bank.
So far, marketplace lenders have concentrated on unsecured consumer credit, with around 80% of loans used to consolidate debt, and small business loans, with an estimated $100 billion in unmet demand exclusively in the US. As per Morgan Stanley Research estimates, marketplace lending has increased over the years. 2014 becomes the leading year in terms of both CAGR as well as loan issuances. China and USA are the most well-known players in terms of loan issuances. P2P operates in china, the USA, Australia and the UK. In china it operates with more than 1500 lending platforms and functioning both online and offline. Peer-to-peer lending platforms today with a guarantee of disintermediation are sustained by a wide range of intermediaries, including banks, secondary markets facilitated by note trading platforms, third party investing tools that analyze loan data and mechanize the investing process, wealth consultative firms that help large investors manage portfolios of loans, and marketplace platforms that match lenders and borrowers within a larger pool of peer-to-peer loan originators.
P2P Lending: The India Scenario
Last decade witnessed the dawn of peer-to-peer lending in the Western market and it soon gained footing. Today, some of the top P2P lending companies operate out of USA and Europe. The concept of P2P lending in India is moderately new and is yet to create a strong foothold. Over the last few years, numerous companies have come to offer peer-to-peer lending services in India and are witnessing a reasonably good response. The Indian market is huge and massively potential for P2P lending platforms. There is a need now to educate and broaden awareness about this to consumers in Indian who are now in the scaffold of formal credit. A financial market as regulated and conquered by legacy like India would require P2P lending companies spotlight strongly on their customers. With high bank rates, stringent loan margins, formalities and documentation conventional sources of credit is slowing becoming out of favour among borrowers. It is in these scenarios that peer-to-peer lending can help borrowers reward quick loans.
As most of the P2P lending platform enables direct dealings between borrowers and lenders, loan settlement becomes an effortless process. With the authority to negotiate for the best interest rates, the borrowers are ensured of loans at justified rates and fast as well. On the other hand, investors with an outlook to invest can discover multiple investment options with peer-to-peer lending. With the ability to choose multiple creditworthy borrowers, investors are now guaranteed of fixed monthly returns. P2P lending service providers have been in business in India since early 2014, but until last year, there was no regulation around it. In September 2017, RBI notified that these will be registered as non-banking financial companies and came out with guidelines for P2P lending platforms a month later.
Major peer to peer lending companies in india are i2i funding, Faircent, Fincy, I-Lend, Len-Den Club, Paisa Dukan, Rupee circle, Cash kumar, Rupaiya Exchange etc. Though there are several websites claiming to be offering P2P lending services in India, RBI has published a list of five companies that have been registered as P2P lending NBFCs. Two more platforms got registered in July, though it has not been updated in the list yet. The list of NBFCs is updated every quarter. The size of the Indian P2P lending market is around 200 crore, said Rajat Gandhi, founder and CEO of P2P platform Faircent, owned by Fairassets Technologies Pvt. Ltd, one of the first P2P lenders in India that got RBI registration.
How Does It Work?
Conventionally, anyone who wanted to take a loan, individuals or businesses, had to apply for one through a bank. The bank in turn would run broadly financial background checks to determine the applicants’ credit score and loan history to decide if they qualified for a loan and, determine the interest rate that was charged on the loan.P2P lending works finest for early-stage start-up’s and entrepreneurs who need to launch their business. These businesses usually seek seed or endeavor funding to obtain the cash to get started. Maybe as an early stage startup you’re not ready or in need of that much cash or you’re not ready to liquidate their equity. Getting a loan from a bank demands higher interest rate and collateral. This is where alternative and non conventional modes of lending like P2P come to play. Entrepreneurs can borrow smaller amounts of money from individuals with effortlessly.
With peer-to-peer lending, borrowers take loans from individual investors who are eager to lend their own money for an agreed interest rate. The profile of a borrower is usually displayed on a P2P lending platform, where investors can view borrowers’ profiles and choose if they want to lend money to them. A borrower might obtain the full loan amount or only a portion of what he asked for from an investor. In the case of the latter, the remaining part of the loan may be funded by one or more investors in the peer lending marketplace.
- Comparing to mutual funds and other investments p2p lending offers more than 15 percentage return monthly
- Ensure the steady return without fluctuations
- Return within a month after investments
- Transperancy and more speed than conventional lending procedures
- More trustworthy as the borrowers profile can be checked before lending
- Safer as the fund tranfering is through the SEBI registerd agencies
- Facilities of reinvestments
Procedure For Lenders
- People who wish to lend are required to register on the online platform
- The platform generally asks for certain documentation for KYC compliance along with bank statements
- Different platforms have devised their own eligibility criteria for lenders. The restrictions are generally in the form of minimum age, minimum annual income, minimum investment required
- Post-registration formalities, the lender is required to transfer the amount he/she wishes to lend to an escrow account (An escrow account is a temporary pass through account held by a third party during the process of a transaction between two parties)
- Loan listings are visible on the lender’s dashboard along with relevant financial, credit and personal details of each borrower. Lenders can use this information to make an informed choice and send a proposal to fund the selected borrower(s)
Benefits To Lenders
- No search for borrowers
- Company will review the borrowers personal, professional and financial status
- Will get the assistance from the recovery agencies in the case of failure of repayment from borrowers
- Borrowers will be compelled to follow the financial punctuality as the company inform the details about those unpunctual borrowers the credit agencies
- Better return than the investments in banks
Procedure For Borrowers
- People who wish to borrow are mandatory to register on the online platform
- Based on KYC and other documentation, the P2P platform does an identity-verification, credit check and risk assessment of the borrower this system is generally programmed through the use of computer algorithms. Some platforms also do a physical verification of the office and residential address
- Based on the credit and risk assessment algorithm, the borrower is assigned with a risk category (for example: low, medium and high). This categorization is used in determining the loan tenure, interest rate and the maximum loan amount. Interest rates normally vary between 12%-36% per annum
- Once the loan is scheduled on the platform, multiple lenders can view the listing and send proposals to fund it at the given interest rate
Fund Transfer And Repayment
- Maximum Total amount a single lender can lent to different borrowers is 10 lack Rupees
- Maximum amount of fund a borrower could borrow from different sources are 10 lack Rupees
- Maximum amount a borrower can borrow from a single source is 50,000 Rupees
- Repayment period is 3 years
- Once the lender and borrower have reached a mutual agreement, the P2P platform facilitates the signing of a legally-binding agreement between the two
- Often, the P2P platforms follow a paperless process wherein the agreement is signed online using digital signatures
- The P2P platform has to open two escrow accounts, one for funds from lenders and pending disbursal and the other for collections from borrowers. All fund transfers are required to be made through these bank accounts and cash transactions are prohibited
- Most P2P platforms also provide legal assistance in case of default. However, the fees for recovery have to be paid by the lender
Fees Charged By P2p Platform
Lenders are required to pay fees for registration formalities and services like loan account statements. Platforms charge 1-2% of the loan amount as transaction fee. General practice is to subtract this fee from the first EMI paid by the borrower
Borrowers are also obligatory to pay registration fees on most platforms. Processing fee in case of borrowers ranges from 2% – 8% (primarily dependent on borrower’s risk profile). This fee is debited from the loan amount and the net amount is disbursed to the borrower. Late payment fees are also charged.
How To Invest In P2P Lending System?
To being an investor in p2p lending, the desired investor have to login to the registerd p2p lending company and fill the application form providing them. Then he has to upload the details of his PAN card details and address. Through this he becomes the investor of that platform.
All the details regarding application for fund from borrowers, and their financial details are available in the site. He can examine and evaluate the details and decide for whom he have to lend the money.
P2P lending has their own systems to ensure the quality and worthiness of the fund applications. Only those applications with is credible will be redirect to the investors
All the agreements regarding the Interest rate and repayment period should be made between the investor and borrower. Agreement, number of repayments, cheques, etc can be transferred through p2p platform. After completing all the procedures the investor should transfer the money to Unique Nodal Escrow Account. The borrower will be delivered this fund from this account. The amount repaying by the borrower will the available to the lender through his Bank Account.
Major Benefits Of P2P Lending:
- Lenders can enjoy returns above those for a bank CD. At the same time, borrowers enjoy similar cost advantages compared with rates at a bank or credit union.
- Many persons like knowing who they’re lending money to and why they need the money. Not only does it give them a sense of personal pleasure, but they can also prefer borrowers who they believe will repay the loan in full and on time.
- There can be a true sense of society at a P2P lender site. Forums tend to be active, and information is keenly exchanged about lending and borrowing experiences. planned changes in the policies of the P2P lender are strongly debated.
- Some people just hate banks and will do anything to evade using them.
Drawbacks Of P2P Lending
- Credit risk: Peer-to-peer loans involve high credit risks. Borrowers who applying for P2P loans possess low credit ratings that do not allow them obtaining a conventional loan from a bank. Therefore, a lender should be aware of the default probability of his counterparty.
- No insurance and government protection: The government does not provide insurance or protection to the lenders in case of the borrower’s default.
- Low liquidity: Cash cannot regain in the case of urgency
- Investor cannot withdraw his cash before period of lending as per agreement
- Foreign cash dealings are prohibited
While P2P lending is a fast-growing sector very significantly after the digitalisation of economy there is certainly fraud and default risks involved. Various non conventional forms of lending emerged out of which peer to peer lending or marketplace lending is one which started as a relatively effortless system for aid loans between individuals online. P2P Lending has gained a firm hold in the Western market and it would be a matter of time before it sets grip in India as well. However, the highly regulated economic system in India would make things time consuming. Having said so, P2P lending would definitely provide a system enabling lenders and borrowers mutually strike a beneficial deal. Peer to peer loans are the easiest to avail with reasonable interest rates.
P2P lending also allows investors earn a profitable margin by investing in credit worthy borrowers. Today these loans are acquired by large investors like banks, hedge funds and wealth management firms. The entry of these investors has stimulate a growth of start-ups and offer to advising investors, performing loan data analysis, and automating the investment process. At a basic level, P2P lending platforms provide a facility building a marketplace where investors who wish to lend funds could find potential borrowers and provide credit through P2P Agreement. This type of non conventional lending system calls for an immense growth in the field of capital market in the economy.