BAJAJ BROKING
September 19, 2024
4 mins read
Lending money has always been an aspect of Indian society that has spanned generations. This could be either in the context of borrowing from a lender for business purposes or borrowing money from relatives in emergencies. Such a form of money lending was usually based on trust as there was little collateral backing such loans.
Now since you have that version of lending already in your head, what would it look like when technology transforms it? That is what peer-to-peer or (P2P) lending is all about.
In case you are still confused, here’s a breakdown of everything you need to know about peer to peer lending.
Though the basis of the question “What is p2p lending?” has already been stated above, let us further dive deep into it here. Peer-to-peer, also known as P2P, is a decentralised transaction. With the help of P2P, individuals wanting to borrow funds and individuals willing to loan funds can interact without any intermediary or traditional financial institutions involved. P2P services are platforms or ways through which individuals can carry out transactions directly.
Here’s a breakdown of how the peer to peer lending provision works:
It is carried out via a website by bringing together borrowers and lenders.
Lenders open an account with a P2P platform, and individuals needing the loan, register themselves as borrowers.
Borrowers are evaluated in several ways including:
Checking their credit scores
Checking their employment history
Checking their Income and credit history
Tracking their social media and app usage habits using various digital tools
After analyzing all these aspects, the creditworthiness of a borrower is decided
Borrowers are assigned different risk buckets based on this creditworthiness based on which the interest rate a borrower needs to pay is decided
Better creditworthiness = lower interest rate for a borrower, poorer creditworthiness = higher interest rate for a borrower
Lenders can pick whom they want to lend their money to based on this assessment by the platform.
This will depend on the risk a lender is willing to take and the return they want to earn from the loan.
A lender’s profile also becomes visible to a borrower once the former reaches out to the latter.
P2P platforms make nothing from the monthly transactions carried out between the lender and the borrower.
These platforms charge a fee from both parties instead.
RBI regulates these platforms to discourage them from indulging in any fraudulent behaviour.
Here is a list of all the benefits that peer to peer lending holds,
The RoI through P2P platforms is usually higher than through any other traditional lending method.
This is because the interest rates offered on P2P platforms are higher compared to these traditional lending methods.
P2P lending platforms help lenders or investors to lend small amounts to many borrowers
This helps investors or lenders spread out any potential risk that might exist from lending a large amount to one single borrower
Apart from investing in securities, using P2P is a great way to diversify one’s investment portfolio.
Lenders or investors can choose between short-term and long-term loans.
Because of this flexibility, lenders can choose loans that align with their financial goals and maintain their risk tolerance.
Apart from this, since there are no fund managers involved, lenders can choose for themselves whom to lend to after considering everything.
P2P platforms are regulated by the Reserve Bank of India (RBI)
This ensures that these platforms steer clear of any fraudulent behaviour
This helps add a safety net for lenders or investors and borrowers as well.
Here is a list of some of the risks and considerations that need to be taken into account when working through a P2P platform:
P2P platforms do not provide any guarantee on the loans that are issued.
Since there is no collateral involved the chance of borrowers defaulting is high
Though regulated by the RBI, P2P platforms are quite a new phenomenon in the investment circuit
As a result, any sudden regulatory changes can impact the functioning
This can, in turn, affect a lender’s or the investor’s returns as well.
Other than the defaulting and regulatory risks, sometimes P2P platforms also end up struggling
Because of this, the sudden closure of these platforms
There could be many reasons for this such as legal issues and security breaches, possibly affecting both lenders and borrowers.
There is a lack of liquidity where P2P investments are concerned.
Pulling out of an investment might be difficult as it is not the same as selling shares or FD withdrawals
This is something that potentially all investments struggle from.
Situations like economic downturns or even rising unemployment could end up affecting borrower’s ability to repay loans.
This could lead to potential losses for the investor or lender
The main element of traditional lending includes the borrowing of funds from financial institutions like banks, non-banking financial companies, etc. Once these institutions analyze the loan applications, they take care of everything from providing funds and handling repayment as well.
To understand P2P lending better, below are some of the main differences between it and traditional lending
Feature | P2P Lending | Traditional Lending |
Mediator/Intermediary | P2P platforms are mostly websites | Involves banks, NBFCs, etc |
Approval of Loans | Less strict criteria to adhere to | A loan approval process is long and strict |
Risk assessment process | Involves detailed evaluation of a borrower’s credit score and even social media activities | Involves traditional credit checks and collateral as a backing for the loans offered |
Interest Rates | Because of competitive lending practices, interest rates are comparatively lower | Since bank overheads are involved, interest rates are higher |
Loan Types | Involves both short-term and long-term loans | Types of loans include personal, mortgage, auto, home, business, etc. |
Loan Amount | Smaller amounts dependent on the lender and borrower | Could be significant depending on a borrower’s credibility |
Collateral Involved | None | Collateral involved especially for larger loans |
Regulatory Practice | Functioning is governed by the RBI | Comes with various strict financial regulations |
Accessibility | Accessing P2P platforms is easier for sections that are underserved | Works better for borrowers who have a good credit history |
Transparency | The fee structure in P2P is very transparent | Traditional lending platforms may have hidden costs and charges |
Repayment Conditions | Repayment is flexible and is usually dependent on the platform, the borrower’s ability and a lender’s needs | Repayment needs to be done according to a fixed schedule. |
P2P lending has a bright future given that it comes with a lot of benefits for both the lender and the borrower. P2P lending provides immense financial inclusion by providing affordable loans to underserved sections of the society, providing access to loans for the poor and supporting the growth of the MSME sector too.
With tech advancements making progress each passing day, P2P lending will not have any accessibility access as one can indulge in it through their smartphones itself. To top that off, the introduction of blockchain tech into the mix will only enhance the security of such platforms, making them safer and more secure for all the parties involved. With easier access to funds, P2P lending will also help promote the growth of startups and help entrepreneurs in their business endeavours.
P2P lending is also monitored by the RBI, making it a safe way to invest and borrow. With this in mind, the popularity of such platforms is also bound to go up, thus encouraging the participation of more individuals in the lending and borrowing process.
Economic downturns might result in credit gaps when we consider traditional lending platforms. However, with access to P2P lending platforms, such credit gaps can be mitigated.
P2P or peer-to-peer lending has truly come up as a great alternative to traditional trading systems.
For lenders, it offers higher returns
For borrowers, It provides easier access to credit since no collateral is involved.
These platforms are regulated by the RBI and offer transparency in terms of the fees involved
Investors or lenders can diversify their portfolios and minimize their investment risk by lending smaller amounts to different borrowers
P2P lending comes with its fair share of risks too and this is why lenders must do their research before becoming a part of the P2P lending world.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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Peer-to-peer, also known as P2P, is a decentralised transaction. With the help of P2P, individuals wanting to borrow funds and individuals willing to loan funds can interact without any intermediary or traditional financial institutions involved.
P2P lending is done through websites on which both lenders and borrowers register. Lenders need to open a P2P account with the platform and borrowers need to go through a thorough evaluation process. Once that is done, individuals can interact amongst themselves and carry out their transactions. The platform does not get any margin from such transactions. It simply charges a fee from both parties for the facilities it provides.
For borrowers, P2P lending offers lower interest rates than traditional lending methods making it more affordable to them. To add to this, repayment options in P2P lending are flexible and can be customized to a borrower’s needs.
For lenders, P2P offers a higher return on interest, the option of diversifying their investment portfolios and flexibility in terms of choosing the type of loan to offer and who to offer it to align with their financial goals.
Where there are benefits, there are risks involved in P2P lending too. From lenders dealing with default from a borrower’s end to the lack of liquidity that such an investment offers, to both the lender and borrower dealing with sudden platform risks like closure due to hacks or fraudulent activities are some of the issues P2P lending can face.
P2P platforms are regulated by the Reserve Bank of India (RBI)
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