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p2p
P2P (Peer to Peer)
Peer-to-peer lending (sometimes called crowdlending), is a direct alternative to a bank loan with the difference that, instead of borrowing from a single source, companies can borrow directly from tens, sometimes hundreds, of individuals who are ready to lend.
What Is Peer-To-Peer (P2P) Lending?
People typically look for a loan from banks or other financial institutions like Non-Banking Financial Companies (NBFCs) whenever they need money. But on many occasions, these institutions reject the loan application based on income, inadequate paperwork, low credit score, etc.
In such a situation, sometimes friends and relatives in their social circle come to the rescue, and people borrow money from them. But those who lend the money only do that when they know the borrower through mutual connections and are confident that they will get back the money. The limitation of this type of lending model is that people can lend and borrow from only a few people in their circle. Thus, many people do not get a source of financing in critical junctures of their life.
Peer-to-peer (P2P) lending can come in handy during such challenging times. P2P lending works as the much-needed mechanism through which people who want to give loans connect with those who require money. The borrowers pay interest, and the investors/lenders earn interest.
Since the transaction directly takes place between the two parties through a website or application, it eliminates the need for financial institutions like banks to act as the middleman.
Thus, as a source of financing, P2P lending has the potential to extend financial inclusion globally. People with low credit scores or people that lie in the low-income category find P2P lending highly accessible. With the help of P2P lending, borrowers can get a loan to finance their education, debt refinancing, expand their business, etc. P2P lending is convenient, as you can do it through websites or applications, also known as P2P Lending Platforms.
How Does P2P Lending Work?
P2P lending is done through a website that connects borrowers and lenders directly. Those who want to lend money, open an account with a P2P platform as a lender. And those who require a loan register themselves as a borrower. These platforms then evaluate borrowers on various aspects. They don’t limit their evaluation to just credit scores. They perform their checks, including the borrower’s employment, income, credit history, etc. Not just that, using technology extensively, these platforms also capture borrowers’ habits through social media activities, app usage, etc. Based on this assessment, the creditworthiness of borrowers is decided, and they are assigned to different risk buckets. It serves as the basis for how much interest rate a borrower needs to pay. The better the creditworthiness of a borrower, the lower the interest rate for him. And the poorer the creditworthiness, the higher the interest rate a borrower has to pay. Lenders can check this assessment done by the platform for various borrowers and pick whom they want to lend their money as per the risk they want to take and the return they want to earn. Similarly, borrowers can also see the profile of lenders and reach out to them. The P2P platforms do not keep a margin from the monthly installments or transactions between the lender and the borrower. Instead, they charge a fee from both for the services that they provide. To make sure that the platforms don’t do anything fishy or fraudulent, like holding on to money invested by the lenders or money paid back by borrowers, RBI regulates these platforms.
How Is P2P Lending Regulated In India?
Since P2P lending is a form of well, lending, it comes under the Reserve Bank of India (RBI). RBI has set guidelines around how P2P lending platforms need to work. For instance, any company which wants to offer P2P lending services need to register for an NBFC-P2P license from the RBI. As the regulator, RBI also ensures that there is no significant systemic risk in these platforms. As per RBI regulations, if a P2P platform decides to shut down, then the company’s board will act according to a pre-decided Business Continuity Plan. The plan has all the details to keep the information of all lenders and borrowers safe. The plan also has nuances about servicing loans for the entire tenure in case of closure of the platform. So these are among the several regulatory measures that RBI has put in place to reduce the risks in P2P lending. That said, P2P lending investment is not entirely risk-free. Let’s understand more about the risks in P2P lending.