The Rise and Fall of P2P Lending in India

Sub: Eco

Sec: Monetary Policy

Peer-to-Peer (P2P) Lending is a form of financial technology (fintech) that allows individuals to lend and borrow money directly from one another without the involvement of traditional financial institutions like banks.
Peer-to-Peer (P2P) lending emerged as an alternative lending mechanism allowing direct transactions between lenders and borrowers without involving traditional financial institutions.
P2P platforms provided tenure-linked assured returns and liquidity options, which attracted many investors, making it a popular choice for informal lending in India.
Every P2P lender should obtain a certificate of registration from the RBI.
The minimum capital requirement to set up a P2P platform is fixed at Rs. 2 Crores.

How P2P Lending Works:

Platform Role: P2P lending platforms operate as intermediaries, connecting borrowers with lenders. These platforms assess the creditworthiness of borrowers, set interest rates, and facilitate the loan transactions.
Borrowers: Individuals or small businesses can apply for loans on these platforms. The loans can be used for various purposes such as personal loans, business loans, debt consolidation, or even real estate.
Lenders: Individuals or institutional investors can lend money to borrowers in exchange for interest payments. Lenders can often choose specific borrowers or diversify their investments across multiple loans to reduce risk.

Regulatory Framework:

In 2016, due to the rise in informal money-lending and global growth of P2P lending, the RBI initiated discussions on whether to regulate the sector.
Concerns included the possibility of:
- Lending legitimacy to P2P lending, stifling growth, and the absence of systemic risks.
- After feedback from stakeholders, the RBI issued master directions in 2017, specifying:
- Scope of activities for P2P lenders.
- Eligibility criteria for participants.
- Transparency and pricing disclosure requirements.

What Went Wrong?

According to an RBI official, P2P platform began to operate like banks, pocketing the spread between the borrowing rate and the interest charged, leading to regulatory intervention.

Key issues identified:

Utilization of funds: P2P platforms were found to be using funds of one lender to replace those of another, mimicking a secondary market behavior, which was prohibited.
Fee disclosure: Lack of clear fee disclosures led to regulatory action mandating platforms to disclose fees upfront.
Closed user groups: The practice of matching and mapping participants within closed user groups through outsourcing was banned by the RBI.