Home >Opinion >P2P lending: will ‘light touch’ regulation work in India?

Indian regulators have been procrastinating about framing regulations for crowdfunding in India, which includes the peer-to-peer (P2P) lending segment. The first paper on the issue was released by the Securities and Exchange Board of India (Sebi) back in June 2014, but guidelines are yet to be finalised. The Reserve Bank of India (RBI) has also been examining P2P lending for some time now and is finally set to put out a concept note for public comments by the end of April.

Ahead of guidelines being finalised, there is talk within the industry that regulators should opt for ‘light touch’ regulation, which will allow the segment to grow but in a safe way. However, that is always easier said than done.

It may be worthwhile to look at some of the issues that need to be tackled.

To begin with, the segment is not large enough at this stage to be seen as systemically important. According to Venture Catalysts, a seed investment and innovation platform, the P2P lending segment could become a $4-5 billion market in the next three to five years. That may not seem large in the context of overall financing activity in India, but as RBI governor, Raghuram Rajan, pointed out recently, the segment can grow quickly. “Before they get big, let us understand them," Rajan told journalists on 5 April. Given that this is a small but growing segment, some regulation is required.

But what form should this take?

The first and obvious step is to ensure that any entity offering P2P lending services be registered with RBI. The industry is happy to submit to this. If anything, being an RBI-registered entity will give greater credibility to a platform offering P2P lending. Industry chatter suggests that there have been some platforms that have been claiming to be ‘RBI-approved’ lenders. A formal registration process will put a stop to this.

The next question: what should be the eligibility criteria to become an RBI-registered P2P lender? The answer to this is less obvious. A P2P lending platform is essentially a technology platform that matches borrowers and lenders. Those running the platform would need some basic understanding of finance but need not necessarily be experienced finance professionals. Yet it may take an experienced finance professional to manage the risk profile of transactions and catch any wrongdoing. So, how do you judge who should or should not be allowed to run a P2P lending platform? The answer to this may lie in applying the broad ‘fit and proper’ criteria to the applicants. For instance, in the case of payments banks, applicants were judged on the basis of “their past record of sound credentials and integrity; financial soundness and successful track record of at least 5 years in running their businesses". A similar broad rule may be applied here.

However, in this case, some form of fit and proper criteria may also need to be applied to lenders and borrowers. At present, the platforms do this informally but some regulatory guidelines here would be useful. Perhaps this could be done by specifying a minimum income level of borrowers and lenders.

Should there also be a minimum capital requirement? It seems logical that there should be. But the amount is debatable. The industry would like a minimal requirement of 1-5 crore since the platform is essentially a facilitator. True enough, but if the regulator wants to ensure that only serious companies enter the segment, it may peg the amount higher than that.

That brings us to the two toughest questions to answer: should the amount being lent or borrowed be restricted, and should the interest rate be loosely regulated in some way?

Those in the business appear to be against any restrictions on the amount. Regulators may see it differently. India has a long and painful history of consumer finance and investment related schemes mushrooming and getting out of hand quite quickly. Capping the individual transaction amount may not kill this risk but could act, at least, as a speed breaker. A loose comparison here would be the microfinance sector where loan amounts to individual households are restricted to prevent over-indebtedness.

The experience of the microfinance sector may also be a useful guide on deciding whether interest rates charged on these platforms should be regulated in any way. The industry is opposed to any regulation of interest rates, but again the regulator may and should see this differently.

After staying away from regulating interest rates in the early years of microfinance, it took a crisis for the regulators to realise that some guidelines are indeed required. RBI now mandates a maximum margin over cost of funds that microfinance lenders can charge. The major difference in the case of P2P lenders is that there is no concept of cost of funds that can be applied here. Funds belong to an individual, so technically he can lend them at whatever rate he chooses. Maybe RBI could look at loosely tying rates to those charged by banks and non-banking finance companies to ensure there is some rationality to the rates charged. This would reduce the attractiveness of P2P lending, but it might prevent these platforms from being used to exploit the genuine need of a borrower.

Ira Dugal is assistant managing editor
, Mint.

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