RBI’s P2P Overhaul: From Risky By-Lanes to a Regulated Highway

The path to P2P lending growth was once dotted with tempting by-lanes. But with the RBI’s latest directive, it’s now a clear highway—no more detours!

There’s been much hue and cry from the industry. Some say the latest P2P directive by the central bank would take back the sector by seven-eight years. Others foresee a number of players shutting shop and surrendering their licences.

However, in my view, this outcome was inevitable. Here’s why!

Intermediaries whose original mandate was limited to matching lenders and borrowers were turning into shadow banks. Platforms were attracting the lender pool by promising guaranteed returns, and devising ingenious ways to hedge borrower default risks.

To address the issue, RBI took key actions:

• Banned P2P platforms from marketing lending as an investment with guaranteed returns
• Prohibited selling insurance products that serve as credit enhancements or guarantees
• Disallowed platforms from holding funds received from lenders for lending and those from borrowers for servicing loans on its own balance sheet
• Mandated fund transfer only through escrow account mechanisms - one for funds received from lenders and the other for collections from borrowers. The funds transferred into the Lenders' Escrow Account and Borrowers' Escrow Account shall not remain in these accounts for more than 'T+1' day.

In other words, P2P platforms go back to being intermediaries rather than assume institutional lending roles.

Why does the move make sense?

Because, although principal guarantees reduce borrower default risk, they expose lenders to the risk of platform failure. Without proper risk management or large reserve funds, even a few defaults can quickly deplete reserves, especially during economic downturns. This can trigger panic, causing lenders to lose confidence and withdraw funds en masse, leading to a "platform run."

How will this affect the existing P2P players?

• Loss of competitive edge: Platforms that once attracted lenders with promises of guaranteed returns will no longer be able to offer these incentives. This may reduce their ability to compete with other investment products or traditional financial institutions, leading to a drop in the lender pool and overall lending volume.

• Supply side disruption: P2P platforms on an average get 70-80% of their lenders through offline channels. No distributor will ever suggest a product to his or her client where the asset gets eroded everyday with constant repayments (when repayments aren’t automatically reinvested, the asset gets smaller over time, reducing growth potential). P2P platforms will either have to redraw their partnership arrangements or switch to open market sourcing - all propositions are likely to incur much higher CAC.

• Operational burden: The T+1 settlement rule requires platforms to track individual borrower repayments and ensure the lender’s withdrawals are only from the funds returned by the specific borrowers they lent to. This can be operationally challenging, especially for smaller players, as they need to implement systems capable of handling such precise fund tracking and disbursement quickly and efficiently.

• Market consolidation: As operational and compliance burdens rise, smaller or less efficient platforms may exit the market, leading to consolidation. Only players with strong financial backing, advanced technology infrastructure, and efficient compliance frameworks may survive, reshaping the industry landscape.

Tightening the reins is fine, but is RBI turning it into a chokehold?

While most of the new regulations fit squarely into responsible policymaking, designed to prevent a repeat of the crisis seen in China’s P2P lending market, there's one that is particularly restrictive - at least in my view.

Banning auto-invest and reinvest options, could hurt the platforms' appeal, especially for lenders who rely on these features to keep their money working without constant oversight.

Auto-invest and reinvest features are crucial for maintaining liquidity and growth for lenders—without them, the platform’s value proposition weakens, as lenders will need to manually reallocate their funds, adding friction to the process.

From the lenders' perspective, the absence of these features would reduce convenience and the ability to optimise returns, particularly in a high-repayment environment like P2P lending, where constant inflows need to be reinvested to maintain growth. This could lead to a shrinking lender pool and fewer funds available for borrowers.

In short, banning auto-invest/reinvest options could unnecessarily limit the efficiency of P2P platforms, making them less competitive, and increasing the operational burden on lenders, which may ultimately stifle the sector’s growth.