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Business News/ Opinion / The future of alternative lending
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The future of alternative lending

P2P lending is indeed a transformative approach that could simultaneously reduce cost and increase access to capital

Jayachandran/MintPremium
Jayachandran/Mint

We have always been told: Never lend money to family or friends. But what about complete strangers? Welcome to the world of peer-to-peer lending (P2P), a platform where people lend money to each other online without the involvement of a traditional financial intermediary (banks and non-banking finance companies, NBFCs).

The 2008 global economic crisis paved the way for innovators. With individuals and businesses struggling to get bank loans, alternative platforms such as P2P lending are becoming increasingly popular. These platforms act as a kind of broker between lenders and borrowers, and offer better rates to both sides.

Also known as social investing, marketplace lending or direct consumer lending, P2P is catching up with traditional banking both in Europe and the US. Companies such as Lending Club (a listed company with a market capitalisation of $5.3 billion) and Prosper Marketplace, Inc. (a $1.9 billion privately-held company) in the US, Zopa Ltd in the UK, and a whole host of companies in China (estimated to be around 2,000) led by Lufax (valued at $10 billion), are redefining how loans are originated and intermediated between borrowers and lenders.

In China, P2P lending has doubled every year compared to just a meagre amount of business back in 2011. When Chinese banks tightened lending in 2013, the number of P2P lenders exploded. According to a report by Grant Thornton, crowd funding platforms in China accounted for 28% of the global deal flows between 2011 and 2013.

How does it work?

P2P lending works differently compared to conventional lending, but the basic risk principles of lending remain the same. Individuals register themselves on a platform as borrower or lender, and submit personal, professional and financial details for verification. The approved listings are published on the websites.

Lenders can choose from a list of verified borrowers. They are also advised to spread their investments to reduce the risk of default. A borrower can receive offers from multiple lenders.

Once a loan is fully funded, the money is disbursed. The P2P platform charges a processing fee that’s between 1% and 4%, from both the parties.

Finding a grip in India

P2P lending is still relatively new in India compared to large markets like the US, China and the UK. However, unorganised P2P lending has been going on for centuries in India, which has a long tradition of community-based financing and lending in the form of chit funds, thrift societies, community associations, and co-operative societies extending credit to their members and participants. It is technology-enabled P2P lending which is new in India. But it is facing challenges.

Currently, the focus is largely on already bankable customers who are eligible for bank loans. Looking at current trends, the rate of interest is hovering between 16% and 20% for a large portion of borrowers. Furthermore, collection of funds from lenders still remains largely in the physical format (i.e., through cheques). This defeats the purpose of P2P lending wherein funds are supposed to be made available immediately to the borrower.

At present, P2P lending is not regulated in India. In the UK and US, the business is regulated by the Financial Conduct Authority and U.S. Securities and Exchange Commission, respectively. In India, only recently did the Securities and Exchange Board of India (Sebi) propose a framework to encourage and streamline the crowd funding market. A strong regulatory framework will go a long way in enabling a sustainable business model. Also, P2P lending formats do not have access to credit bureaus such as Credit Information Bureau Ltd (Cibil), which can help analyse the credit worthiness of borrowers more effectively. Some of them have tied up with NBFCs to get access to credit scores. A Cibil subscription, however, remains out of reach till there is more clarity on the regulatory front.

India needs about a trillion dollars in investment to ramp up its infrastructure in the next few years. If the general population can do a better job of lending and financing each other under a robust system, it potentially frees up funds for nation building, albeit in a small way.

In the past eight months, Faircent’s (a P2P lending platform) market place has had lenders committing nearly $4 million, and about 6,000 borrowers seeking over $3 million. Currently, the largest chunk of its lending is for business funding (30%), followed by debt consolidation (21%). Borrowers have also taken loans for personal requirements such as marriage, family events, home improvement and education (7% each). The end use of the loan is divided equally between business and personal purpose.

P2P lending is indeed a transformative approach that could simultaneously reduce cost and increase access to capital. This would be a boon for a capital-starved country like India.

Ritesh Jain is the chief investment officer at Tata Asset Management Ltd. With inputs from Amey Sathe, research analyst (banking).

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Published: 12 Oct 2015, 06:51 PM IST
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