P2P or peer to peer lending has emerged as one of the key sources of procuring capital in recent years.
P2P is based on the principle of raising finance from “n” number of people who pool their resources together. There is no proper definition of P2P lending. One can define it as a method of debt financing that enables individuals to borrow and lend money without the use of an official financial institution as an intermediary. It can be also explained as a financial innovation introduced with an objective to provide funding to people by connecting borrowers directly with lenders through an internet platform.
This system reinforces the power of crowd funding. The reasons for want of funds can range from professional to personal reasons like commencement of business, expansion or diversification of business, wedding, purchase of property, education fund, etc..
The need for P2P lending structure arose because Banks and financial institutions could not or felt reluctant to grant unsecured and small amount of funds. Although the demand for such unsecured and small funds remains high, moneylenders or individual bankers are the only ones catering to this sector who charge an exorbitant rate of interest being a monopoly.
The working concept of P2P is similar to a marketplace where buyers and lenders meet to enter into a debt financing agreement. This lending structure makes use of technology and online media to maintain communication between the parties, known as P2P platform.
The terms and conditions including the interest rate and duration are either mutually decided by the parties or by P2P platforms with the approval of the parties. The role of P2P platform is to introduce creditworthy borrowers to cash rich individuals who cannot be accessed by the individual borrowers generally.
Lenders make use of Reverse auction model, that is, the lender bids for the rate at which he/she wishes to lend a specific amount of money and Buyer shall have the right to choose among the Bidders, from whom they wish to borrow. Naturally, the lender with the lowest bid rate is preferred by the borrower. Prior to investment, the Lender can verify the credit score of borrowers at P2P platform without any actual interaction with the other party. These platforms have their own criteria’s of assessing the credibility of individuals and may physically verify the personal details of the borrowers. At the time of entering into debt agreement, post dated cheques may be taken from the Borrower to secure the repayment to Lender. All the transactions are made directly through bank accounts of the parties, which ensures that one round of customer verification is done through KYC norms of Banking institutions.
The P2P platform functions in the following manner:
1. Application of loan by Borrowers is made online on P2P platform.
2. Next is, evaluation of Borrowers to grant credit scores through data analytics. The method of assessment of borrowers depends upon the policies and practices of P2P platform.
3. Approved loan requests are then assigned a credit grade, which serves as a platform-specific rating system that reflects a distinct interest rate and affiliated levels of risk.
4. If the borrower agrees to the terms of the loan, then the platform uploads the borrower’s details onto the online marketplace as a distinct profile for the investors to review.
5. Multiple investors can invest in a single piece of loan for portfolio diversification and risk distribution.
6. Once the borrower and investor agree upon the interest rates and other terms and conditions, the agreement is vetted by the P2P platform.
7. The amount is deposited to the account of P2P platform by the investor which is further directed to the borrower’s account.
8. The entire process of lending and timely payment of returns is monitored by the platform.
9. The platform receives a fee on the loan for their services.
The major benefit of P2P is the availability of right amount of fund at the right time. While returns from fixed deposit can never beat inflation and equity returns can never be assured, P2P gives assured and timely risk adjusted returns. No lock in period is applicable here as the returns start at periodic intervals like monthly or bi-monthly payment. These periodic returns can be further reinvested in other investment vehicles or at the same P2P platform for earning revenue at compounding rates. P2P is thus, not only a better source of financing but investment too.
For an orderly growth of P2P lending in India, RBI has recently released a consultation paper on its regulation inviting suggestions from public. Once regulated, more people will start using the platform. At the same time, the fear of overregulation looms over the participants of P2P lending.
As the name suggests, any direct lending from one person to another can be categorized as peer to peer lending. It can be safely deduced that it is not a recent phenomenon but it was the Bank which had replaced such individual financing system in the past.
The revival of P2P lending system can be attributed to its digital makeover. In 2005, Zopa an online platform for peer to peer lending was introduced in UK. Based on this concept, several online platforms came up worldwide.
Within few years, P2P online platforms became popular in Indian capital market as well. At present, around 30 startups are in the P2P lending business.
As goes for any innovation in financial market, there is always a comparison for superior returns. Similarly, the comparison of Real estate Investment Trusts (REITs) and P2P lending by investors is inevitable. Both are new formats of investment capable of investing in real estate. However, there are various factors to look out for before choosing an investment vehicle. Hereinbelow is a snapshot of the differences between the two investment structures:-
Growth of P2P lending in real estate is not surprising, given the different client base of this system. The client assessment for P2P lending is totally different from banks and financial institutions as they do not reject borrowers on sole factor of financials and prefer credibility for shortlisting borrowers. Applying this concept to real estate, there is a large segment of medium- income population in need of homes. Banks lend money to this segment only if they give security and agree to a high rate of interest. In such scenario, P2P lending is a boon to the Indian economy.