P2P lending: Finding the right balance
5 min read 20 Jun 2016, 04:19 PM ISTGiven the peculiarities of India's economy, it needs to be seen differently from other global P2P markets; we require the right mix of regulatory practices to guide this model's growth
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The consultation paper on peer-to-peer (P2P) lending, released by the Reserve Bank of India (RBI) in late April, is an acknowledgement of this business model’s growing significance.
The paper has proposed a balanced approach to help P2P lenders flourish as well as safeguard them from the risks inherent in the model.
The concept, which started with only individuals as participants, has extended its reach to include micro, small and medium-sized businesses, proprietors, retailers and the like. P2P lending is now moving away from the online mode of lending to establishing offline channels by entering into partnerships with leading banks, making them fund custodians.
According to a Morgan Stanley research (Can P2P lending reinvent banking?), P2P lending is estimated to increase to $290 billion globally by 2020, growing at an expected compounded annual growth rate of 51%.
The RBI has proposed six key areas for framing the regulatory guidelines around P2P lending. These areas include permitted activity; reporting, prudential and governance requirements; business continuity planning; and customer interface. These guidelines strive to cover the whole gamut of the regulatory framework.
Looking closely at these six areas, the scope of permitted activities needs to be defined clearly, especially in view of the aggressive expansion plans of P2P entities. The RBI could consider framing guidelines on the clear display of the representative annual percentage rates and risk and reward benefit analysis, to be explained on the website. The guidelines should also explain the regulator’s position on borrowers using multiple platforms for loans against the same purpose or use.
Given the potential of rapid growth—and the aggressive lending plans by P2P players this is likely to lead to—there is also the possibility that questionable practices such as credit enhancement or other financial incentives offered by the P2P platform will creep in.
Keeping this in mind, some prudential norms need to be in place if these platforms are allowed to give a guarantee. Alternatively, these platforms could also avail of specific products such as credit risk protection from a registered Indian insurance company. Otherwise, there is a possibility that many lenders could be duped into investing because of the guarantee, which the P2P platform might be unable to fulfil at a later date. Perhaps, their performance should be observed for some time before the RBI allows them to continue with their guarantees. If the RBI does allow it, there should be a provision/insurance against this guarantee.
Additionally, the growth of P2P lending in India could invoke interest from foreign entities to invest in India. 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 P2P lenders 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 entities as well as those whose portfolio exceeds a particular ticket size. These could include a high level of scrutiny—for example, a periodic assessment of the lending pool by an independent credit rating agency.
The RBI paper mentions that the funds should only flow from the lender’s bank account to those of borrowers. However, this practice could result in an operational complexity or delay as many a times, the platform might pool funds from several lenders for one borrower.
Many global platforms open a direct investment account of the lenders, which is likely to be pre-funded for lending at a later date. This account ideally is a third-party administrative account managed by independent parties from which lending is being done.
At the back-end, the RBI could enforce an arrangement similar to pre-paid 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. This move could give some operational flexibility to P2P platforms for tracking disbursals and collecting payments/commissions.
The RBI’s proposal to make it mandatory for P2P lenders to set up a brick-and-mortar presence may also go against the viability of the business model. While an office registered in India housing employees and other infrastructure would enable the regulator to visit and scrutinize records periodically, it may lead to operational inefficiencies. That is because P2P platforms employ cloud-based servers for reducing costs and make the operating model lean.
Instead of a pre-condition requiring them to maintain a physical office, disclosure requirements for their websites could increase the platforms’ efficiency and improve transparency. It might even enable lenders and borrowers to transact in a stable environment. The RBI could take a cue from the “online only" banks in other countries (such as Atom Bank in the UK), which have no brick-and-mortar presence at all.
The RBI will presumably cover the confidentiality of customer data, both from a lender and borrower perspective, well. However, the mechanism through which P2P platforms can recover bad loans needs to be emphasised. The platforms can provide a subscription-based fee model for those lenders who want an offline collection agent facility, wherein the P2P lender can deploy outsourced offline collection teams for specific lenders who opt for such a facility. These P2P platforms are treated on par with other credit institutions for the purpose of sharing and receiving information from credit bureaus.
P2P lenders must submit quarterly reports to the RBI, stating their financial position, volume and the nature of loans disbursed. They can also be required to make public disclosures, which is likely to instil more public trust and confidence in the P2P lending business. Public disclosures could include delinquency levels of the portfolio, credit losses, the platform’s financial position, and so on. The periodicity and extent of disclosure should be specified by the RBI.
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, which can be handed over in times of business default. The responsibilities of the board of directors 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 evolves. One such area is protecting the interests of stakeholders, especially lenders, in case the P2P platform goes bankrupt. There should be clarity on what can happen in such an instance—for example, will all contracts continue to stay enforceable and how will investors be serviced?
P2P lending has the potential to become disruptive. Hence, its platform guidelines should not promise extraordinary returns to lenders. Given the peculiarities of India’s economy, it needs to be seen differently from other global P2P markets. We require the right mix of regulatory practices to guide this model’s growth.
Naresh Makhijani is partner and head, financial services, KPMG in India. Views expressed are personal.
