Before you experiment with this latest fad, be aware of how these loan products work
With interest rates on bank deposits at rock-bottom, fintech players are tying with peer-to-peer (P2P) lending platforms to showcase loan products as a lucrative alternative to bank deposits or mutual funds. But before you bite the bait and sign on as an investor in one of them, you need to be aware of how these loan products work.
They’re loosely regulated
P2P lending platforms are RBI-regulated, but the regulations are far sketchier than those for banks or mainstream NBFCs. While a bank or NBFC is required to adhere to dozens of norms on net worth, loan composition, capital adequacy, leverage, recognition of bad loans et al, P2P platforms only need to have net owned funds of ₹2 crore, cap their leverage at two times, while they stick to unsecured loans for tenures up to 36 months.
When signing up, you may need to do some digging to know if you’re dealing with a regulated P2P platform, as they usually operate through tie-ups. The regulated entity that is facilitating your loan and thus is under RBI’s watch, may be two steps removed from the fancy app or front-end fintech player you’re interacting with. For instance, for its P2P lending business, CRED Mint states that it has tied up with Liquiloans, a P2P platform. However, Liquiloans by itself does not figure in RBI’s list of registered P2P entities. Instead, Liquiloans appears to be brand name used by NDX P2P Private Limited which is an RBI registered NBFC-P2P. Do ensure that you peel the onion to verify if the P2P platform you’re dealing with is registered with RBI. You can do that here: https://tinyurl.com/p2prbilist
You’re lending, not investing
While wooing lenders, many P2P platforms plug the 2X or 3X ‘returns’ on their loans compared to returns on investments such as bank fixed deposits or mutual funds. But don’t let the promises of compounding and wealth generation mislead you into believing that lending on a P2P platform is the same as investing with a bank or mutual fund. When a bank borrows from you, its promise to repay you is backed by many regulatory safeguards such as the Statutory Liquidity Ratio, Cash Reserve Ratio, deposit insurance and so on. If bank fails to honour its promise, it can spell doom for its business. Indeed, that’s why the government and RBI often step in to rescue banks even before there’s first whiff of a default. With a mutual fund, there’s a professional fund manager selecting bonds or stocks and her/his performance is benchmarked against peers and the index.
But on a P2P platform, you’re essentially lending to a stranger who has happened to approach you through an app. The platform may use fancy algorithms to filter and present to you individuals whom it thinks are credit-worthy. But ultimately the borrower’s ability and his or her willingness to repay you, will decide if you’re going to get back your money. Unlike other ‘investments’, your principal in a P2P transaction is always at risk and the high interest rate compensates for this risk. In fact, if a borrower is willing to pay 2X or 3X bank deposit rates, that shows how high the risk to your principal is. Check the portfolio performance metrics of a P2P to see default rates of borrowers. The more information that a platform gives you on this, the better-equipped you are to gauge risk.
You’re dealing with individuals
P2P platforms in India are of very recent origin and don’t have established institutions backing them. They, therefore, tend to showcase their pedigree by highlighting the private equity and angel investors who’ve funded them, or business houses they’re partnered with. But private equity investors are often just financial investors in P2P platforms who don’t play an active role in their running. Business partners who’ve tied up with the platform are likely looking to their own business interests for a fee.
When you’re lending on a P2P platform, be aware that you’re not dealing with an institution, you are dealing with the individual or individuals you are lending to.
The platform is merely playing the facilitator to this transaction. RBI rules clearly specify that a regulated P2P NBFC can only be an intermediary providing an online marketplace, where lenders and borrowers meet.
It cannot raise any deposits from you, lend its own money or even hold any money on its own balance sheet. The platform also cannot provide any guarantee that borrowers will repay their loans or allow them to offer any security against their loans.
The P2P loan is essentially a contract between an individual borrower and individual lender. This makes it important for you to understand the credit score and credit worthiness of the borrower or borrowers you are lending to and terms you are signing off on. Whenever you make a transaction, the platform is required to disclose to you the personal identity of the borrower, the loan amount, interest rate and credit score, apart from the loan contract itself.
Know your liabilities
When there are defaults, P2P platforms use either internal or hired staff to facilitate recovery of loans. While P2P platforms admit to using both ‘hard’ and ‘soft’ methods for recoveries, the RBI has a very strict code in place on the practices that all NBFCs may and may not employ to recover loans from defaulters.
When a P2P platform attempts recoveries of your loan, it effectively acts as an agent on your behalf. Any hardball tactics it or its agents use can reflect or backfire on you.