The quest for lower rates and easier repayment norms continues for customers grappling with interest rates as high as 36% on their credit cards and personal loans. The traditional business model for banks has been that of collecting low-cost retail deposits and lending them at much higher rates. The rates offered are a function of the administrative and risk-related costs associated with the customer and his funding requirements.
On the other hand, retail investors continue to seek investment options that can beat inflation and fixed deposits and not be over-leveraged in the stock markets at the same time.
A new format of retail finance has emerged that is proving to be the new disruptive force in the retail banking and finance space, referred to as social lending. This is a classical peer-to-peer (P2P) lending, rather synonymous with moneylenders who flourish across the country, but in a more transparent and efficient manner. The structure is quite simple, wherein lenders and borrowers aggregate in an Internet-based network. The aggregator provides a mechanism by which persons seeking borrowing status are checked for their creditworthiness, and rated on the basis of their credit scores and past financial track record. Only those meeting the desired credit norms are permitted access into the community as borrowers. The borrowers can then present to the community a description of the need for the loan and can even be endorsed by other community members.
The lenders step in and commence bidding for business from customer groups of similar credit profiles, submitting offers, rather like an auction system. The aggregator is responsible for the transactional management services, including collecting the funds from the lender, forwarding them to the borrower and periodic debiting of the borrower’s account for the equated monthly instalments. The aggregator charges a transaction fee to the lender and borrower, and facilitates collections in case of defaults. The efficiency of managing via the Internet has typically resulted in rates for borrowers being lower than those offered by established and dominant financial institutions and lenders, making more money than they would have on classical bank deposit instruments.
It was pioneered by Zopa, which commenced operations in the UK in 2005 and followed up in Italy and the US, and a host of other players including Prosper, Smava, Boober and now Virgin Money have commenced P2P lending operations subsequently in Europe and North America.
P2P players have propounded the efficiency of social lending for end consumers as there are no large branch, employee and related infrastructure costs in these transactions. However, critics have been on the fence as there was a need to understand better, over a longer time frame, the risk potency of these portfolios vis-à-vis those of conventional lending organizations. Zopa and a host of other players have progressed rapidly and appear to have addressed the concerns of critics about the long-term sustainability and scalability of their business model.
As the P2P social lending movement rapidly picks up momentum in Europe and North America, it’s time perhaps to understand its significance and opportunity presented for India.
There are three factors that make this the right time to be able to evaluate the realistic opportunity for social lending to emerge in India in the near future. The first is the imminent introduction of the social security number concept, commencing next year, which—along with the permanent account number—allows a unique set of identifiers for individuals in India. The second is the introduction of a credit score by Sibil and Transunion allowing lenders to have a consistent quantitative approach to evaluating creditworthiness, along the lines of the Fico score that exists in North America. The third is the introduction of the Payments Bill, potentially allowing third parties to be recognized by the Reserve Bank of India for performing clearing and settlement functions. These factors, aided by the rapidly expanding Internet- savvy populace, offer the ideal building blocks for setting up a framework for social lending.
Social lending can address two need segments in India. The first in enabling competitively priced low-ticket loans, initially for those required by individuals in micro-communities such as college alumni, friends and family circles, hence lending to persons with whom you may have a social/ emotional connect, followed by lending to unknown individuals. This would enable the network community to better understand the mechanics of the system before venturing out further, given the risk perceived to be associated with lending to persons you do not know at all.
The next opportunity lies in enabling loans to members of less privileged sections of society who cannot access funds at competitive rates vis-à-vis the moneylenders. Entrepreneurs shortlisted and backed by non-governmental organizations (NGOs) and microfinance institutions can present their case and seek loans from retail investors such as ourselves as demonstrated by Kivo, which is beginning to find traction.
As microfinance institutions and NGOs strive to procure funds, the Internet-based P2P lending model provides an effective medium for retail investors to earn as they contribute to the development of the economy. This would also excite a larger retail investor population to view participation in this domain as a socioeconomic enterprise and not just as charity!
Upendra Namburi is a senior banking and finance professional with a multinational company. Comments are welcome at firstname.lastname@example.org