P2P lending: towards easy funding

The consultation paper on peer-to-peer (P2P) lending, released by the Reserve Bank of India (RBI) in late April, proposes a balanced approach to help P2P players flourish as well as safeguard them from various risks of business fallouts.

The concept, which started with only individuals as participants, now includes micro, small and medium-sized businesses, proprietors and retailers. Through partnerships with leading banks, P2P lending is now moving towards offline channels. According to Morgan Stanley research, P2P lending is estimated to increase to $290 billion globally, growing at an expected compound annual growth rate of 51%.

RBI has proposed six key areas to frame the regulatory guidelines around P2P lending. These include permitted activity; reporting, prudential and governance requirements; business continuity planning and customer interface.

To begin with, the scope of permitted activities needs to be defined clearly, especially in view of the aggressive expansion plans of P2P players. Potentially, RBI could consider framing guidelines on promotions and advertisements being displayed on their websites. These will ensure that there are no comparisons between either the rate of return or interest rate from the perspective of lenders and borrowers, respectively. Further, these guidelines could also include a clear display of the representative annual percentage rates, risk and reward benefit analysis. The guidelines should also explain the regulator’s position on borrowers using multiple platforms for loans against the same purpose.

The aggressive lending plans of P2P players may lead to questionable practices such as credit enhancement or other financial incentives offered by the P2P platform. If these platforms are allowed to give guarantees, then some prudential norms need to be put in place. Alternatively, P2P lenders could also take the benefit of availing specific products, such as credit risk protection from a registered Indian insurance company. There is a possibility that many lenders could get duped into investing because of the guarantee, which may be difficult to meet at a later date. Perhaps, their performance should be observed before the RBI allows them to continue with their guarantees and if approved, then provide them with an insurance against it.

Additionally, the growth of P2P lending in India could invoke interest from foreign players to invest in the country. It is presumed that the guidelines on foreign investment, as they now apply to a technology platform, would also apply to P2P platforms. There needs to be clarity on the maximum ticket size of transaction that can be serviced by a P2P lender to clearly differentiate them from other lenders, such as microfinance institutions and banks.

Like other non-banking financial companies (NBFCs), there could be more stringent norms for systemically important players as well as whose portfolio exceeds a particular ticket size. These could include a higher scrutiny, for example, a periodic assessment of the lending pool by an independent credit rating agency.

Allowing funds to flow from the lender’s bank account to that of the borrowers could result in an operational complexity or delays. Many global platforms open a direct investment account of the lenders, which is likely to be pre-funded.

To gain operational flexibility, at the back-end, RBI could enforce an arrangement similar to prepaid instrument issuers, wherein all the funds can be parked in an account opened in a scheduled commercial bank and used only for lending to borrowers.

The compulsion for P2P lenders to set up an office will enable personal scrutiny of records, but could result in operational inefficiencies. Instead, RBI could take a cue from the ‘online only’ foreign banks. Mandating disclosure requirements on their websites can increase efficiency and improve transparency of the model.

The confidentiality of customer data seems to be well covered by RBI. However, there is no emphasis on the mechanism through which P2P platforms can recover bad loans. The platforms can provide a subscription-based fee model to those lenders who want an offline collection agent facility.

The P2P lenders are required to make public disclosures of their quarterly reports to RBI. This could include important parameters, such as delinquency levels of the portfolio, credit losses and the platform’s financial position.

The Business Continuity Plan (BCP) for P2P lenders needs to be well-devised. These players may need to store the documentation work, post-dated cheques and other business records, to be handed over in times of business default. The responsibilities of the board and senior management need to be outlined, as in the case of banks. A BCP committee can be set up, which can also perform business impact analysis and risk assessment.

Since P2P lending is still a new concept across global markets, new issues continually emerge as the model matures. One such area is protecting the interests of stakeholders, especially lenders, in case the platform goes bankrupt. There needs to be clarity on whether all contracts will continue to stay enforceable and how will investors be serviced.

To conclude, P2P lending has the potential to be disruptive. Hence, its platform guidelines should not promise extraordinary returns to lenders. India being a peculiar and fast-paced economy, it requires a mix of good regulatory practices to balance the growth of this model and fair practices.

Naresh Makhijani is partner and head, financial services, KPMG in India. Views expressed are personal.

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