P2P lending at the edge of Regulation

While Capital Markets regulator SEBI is working on to setup a regulatory framework for Crowd Funding in India, Banking regulator RBI has come up with a consultation paper on it's website to elicit opinions and views from the various stakeholders in the public domain on the future course of action for the nascent unregulated peer-to-peer(P2P) lending business having regard to the current legal and regulatory framework in place to regulate the business of financial intermediation.

The online peer-to-peer lending marketplace, popularly known as P2P lending market, connects borrowers and lenders through an online platform, thereby cutting out the traditional banking and NBFC protocols. These platforms do not lend their own funds but act as facilitators to both the loan-seeker and the loan-giver.

Though this space is quite nascent in India with approximately 30 startups working on this model, RBI coming out with a discussion paper to set out the rules for this business highlights the fact that the regulator is cautious of the fact that it has the potential to disrupt the traditional channels of providing credit through Banks and NBFCs and if the business model is not aligned to come under a regulation ambit, it may throw up surprises in future.

Now coming to the proposed regulations, the ones which will involve lot of feed-backs from the community

• P2P lending platforms need to register themselves as NBFCs. Here the concerns that would pop up would be that imposing NBFC like regulation on a market place model. Online P2P marketplace acts as a facilitator which is capital light whereas NBFCs has the loan book on it's balance sheet.
• Funds must move directly from lender's account to borrower's account to prevent the risk of money laundering. Though the intent of the regulation is good, it poses operational challenges for the marketplace from an accounting perspective which pools money in an escrow account from multiple lenders to fulfill a borrower requirement. There should be a mechanism in place where the P2P lending platform is in the loop on all transactions
• The platform may need to adhere to a leverage ratio so that they do not expand indiscriminately. This may not seem reasonable to many. Leverage should be controlled when the model has inherent business/economic risk using excessive leverage. Unless a P2P marketplace is guaranteeing to compensate for borrower's defaults (which is unlikely), the only significant risk in this model is operational risk as the credit does not come from the platform

The below proposed regulations seems rational and should be embraced by most of the stakeholders as it will bring trust and respectability to this nascent business.

• Minimum capital requirement of 2 crore for the company
• The platform can't assure guaranteed returns to lenders
• P2P marketplaces must act only as intermediaries and their role must be limited to bringing the borrower and lender together
• The companies should have brick and mortar presence in India
• Companies need to register under Companies Act and cannot be run as individuals, proprietorship, partnerships or limited liability partnerships
• The platforms will have to guarantee confidentiality of customer data.
• Promoters, directors and chief executive officers of P2P platforms will have to meet a so-called “fit and proper” criteria.
• A background in finance for some proportion of the board members of such platforms.
• Platforms will need to submit regular reports on their financial position, loans arranged each quarter, complaints and so on to RBI.
• Loan-recovery practices will need to adhere to existing guidelines on recovery practices.

The paper do not mention anything about the credit risk assessment of the borrower. From a business model perspective, given most of the P2P platforms target the borrowers with thin credit history who do not get competitive rates from traditional channels, robust credit assessment at scale using alternative means will differentiate the best from the average. This would mean borrowers get the best rates and lenders deal with less defaults and the trust on the system increases.

To conclude, an appropriate regulatory framework will facilitate the orderly growth of this sector so that its ability to provide an alternative avenue for credit for the right kind of borrowers is harnessed and provide alternative means for individual lenders to lend money. Only requirement is that the guidelines should strike a balance between over-regulation and under-regulation.