- By Naliniprava Tripathy, Ayus Dharnidharka & Nikita Agrawal
The last decade has witnessed an exponential surge in the online social community that has revolutionized communication across boundaries. Integrating social networking with financial services has given birth to peer-to-peer (P2P) financing. P2P financing enables both borrowers and lenders to interact on the same platform connecting users online. Instead of a bank intermediating between savers and borrowers, the two parties deal with each other directly.
Getting loans from individuals without any intermediary is the fundamental essence of P2P financing. Lenders are better off with higher interest incomes, borrowers with cheaper sources of fund and market makers with a deal fee. It ushers in the opportunity for the democratisation of finance, as investors get to decide whom to invest in and borrowers get to negotiate interest rates. However, the lender’s investment is not protected by any guarantee.
In P2P financing, lenders provide clean loans or secured loans, to borrowers and charge interest on their investment. In India, Tier II and Tier III cities have limited borrowing options like the traditional banking system, employers or conventional money lenders. Many people are not able to borrow from these sources due to reasons such as small loans sizes, short loan tenures, difficulties in credit assessment of borrowers and high risk for banks.
In P2P format, lenders lend money and earn interest income, while borrowers get access to Short-term finance. The simplicity and swiftness place P2P financing platforms at an advantageous position vis-a-vis traditional lenders. The P2P financing finds most of its segments in customer credit card, student loans, small business loan, and real estate loan. P2P is suited to grow in emerging markets because of the low penetration of tradition financing and lower interest rates.
The growth of Internet, penetration of smartphones, and increasing popularity of online transactions have led to the digitalisation of peer-to-peer financing. It has made the process of P2P financing- simpler, convenient, cheaper and bigger wherein the location of a lender won't hinder him from lending a creditworthy borrower through trustworthy services of a P2P platform, regulated by RBI. Both secured and unsecured form of lending takes place in this market.
How does peer-to-peer financing works?
Peer to peer financing has lower intermediary charges and regulatory overheads, and extensive geographical outreach, making the entire process cheaper. One person can lend to others by entering into a loan agreement, P2P platforms make such a process more accessible and provide a marketplace of lenders and borrowers. One can either enter in P2P financing through the traditional offline loan arrangements as followed by self-help groups or can avail the services of online P2P platforms.
As such, platforms handle the financial data, they are required to maintain confidentiality and operate only as per set instructions. The funds remain safe in the escrow accounts for lending money and collecting EMIs. They are either transferred to the borrower or repaid to the lender as per lenders' instructions. One can register as a borrower or lender on such portals by providing necessary details like name, PAN, expected rate of return, amount to lend or borrow and expected borrowing.
What is the future of P2P financing?
Status in India
In India, peer-to-peer financing is currently less regulated. Most of the P2P platforms are in a nascent stage. Several P2P platforms started operations in 2012. According to a PwC report, India currently has around 30 online P2P platforms, with a loan book of $25 million. This number is expected to grow to $4 billion in the next five years. Len Den Club is India’s leading P2P financing company, along with other prominent players like Faircent, Liquiloan, Peerlend and Lendbox.
The Indian lending market is vast, and there is an enormous potential for peer-to-peer loans. Also, the need for small loans is paving the way for peer-to-peer loans. Financial institutions seldom allow small loans, and if borrowers are looking for lesser than Rs 50,000, getting a loan can be tough. Peer-to-peer comes with several benefits for both investors and borrowers.
P2P financing is a transformative funding method that can lessen the cost and increase access to capital. Hence, this can be a boon in a capital-starved country like India.
(Naliniprava Tripathy is Professor (Finance) at IIM Shillong. Ayus Dharnidharka & Nikita Agrawal are PGP Final Year students, IIM Shillong.)