Over the last one week, two fintech giants, CRED and BharatPe, announced their entry into the peer-to-peer lending space, or P2P lending, as it’s commonly called.
CRED Mint and BharatPe 12% Club are the newest lending products on the financial block. However, the concept of peer-to-peer lending isn’t new. Today, we’ll explore what this form of investing and borrowing is all about, how it works, and what one should be wary of.
What is P2P lending, and how is it different from a Bank?
As the name suggests, peer-to-peer lending enables an investor to lend to a borrower without involving a regular bank. A platform, like CRED or BharatPe, provides the interface for the investment and borrowing transactions to take place.
Let’s say your friend, Riya, has been using the CRED app to pay her credit card bills for months. She now finds that she can park her idle funds with this newly launched product, CRED Mint. By doing so, Riya earns an interest of upto 9% per annum on her investment. This is much higher than the measly rate of 3-7% p.a. that banks offer on savings accounts, and term deposits. Furthermore, Riya can withdraw her funds any time she wants.
Now comes the lending. Riya’s investment is used to lend money to other users of the app looking for loans. The borrower benefits by not having to go through the tedious process of applying for a loan at a bank. Moreover, the lending rate is lower than that charged by banks. Interest rates on personal loans are anywhere between 11-24% per annum. Because P2P connects lenders and borrowers directly, the middleman is eliminated, thereby reducing costs.
Isn’t the P2P platform just another middleman?
Yes, and no.
UK-based Zopa, founded in 2005, was the first P2P lending platform in the world. Prosper and LendingClub followed in the US. Ten years later, India saw her own lending platforms emerge, Faircent being the first RBI-registered P2P platform. It was only four years ago that the Reserve Bank of India issued regulations on peer-to-peer lending.
The actual lending takes place through partner non-banking financial institutions (NBFCs). For instance, CRED has partnered with LiquiLoans, an RBI regulated P2P NBFC. What the P2P platform deals with is getting borrowers and investors on-board, analysing and verifying their credit-worthiness through data gathered, and payments and collections. So, fintech companies like CRED, aren’t really acting as intermediaries the way banks do. Having said that, they are, in a sense, middlemen in terms of making the whole process of lending and borrowing seamless.
RBI Regulations and Risks Associated with P2P Lending
The biggest risk associated with this form of lending is when borrowers default on payments. Investors lending money through such platforms, must understand that the loans given out using their funds are unsecured loans. There is no collateral obtained for these loans. It is this high risk that results in high returns. But as CRED puts it, their product CRED Mint is reserved for only a few, and loans are given out only to their high-trust members.
Nevertheless, RBI guidelines aim to regulate this sector. Some of the pertinent guidelines require P2P platforms to:
- Limit the maximum investment from a single investor on a single P2P platform to ₹10 lakh, and ₹50 lakh aggregate across all P2P platforms.
- Cap the aggregate loans taken by a single borrower across all P2P platforms to ₹10 lakh.
- Exposure of a single investor to a single borrower is subject to a maximum of ₹50,000.
A Caveat for those Planning to Join the “Club” and “Mint” Money
If you’re planning to sign up for BharatPe 12% Club or for CRED Mint, there are just a few simple things to keep in mind.
Our idle funds usually earn next to nothing when they lie in our savings bank accounts. While peer-to-peer lending is a way for us investors to earn a little extra on these funds, I would not recommend them as a weighty investment avenue. Consider it part of your liquid/emergency fund, if you will. The unsecured nature of such an investment comes with its own set of risks as we’ve just seen.
As far as borrowing is concerned, personal loans carry some of the highest interest rates, making them one of the most expensive loans. Always remember, the lesser your liabilities, the greater is your financial freedom.
