What is peer-to-peer lending?

Peer-to-peer lending (P2P) platforms would be treated as non-banking financial companies (NBFCs) and regulated by the Reserve Bank of India (RBI).

1. Peer-to-peer lending is a form of crowd-funding used to raise loans for people who need to borrow, from people who want to invest.
2. It enables individuals to borrow and lend money without any financial institution as an intermediary, and extends credit to borrowers who are unable to get it through traditional financial institutions.
3. The main idea is savers getting higher interest by lending out their money instead of saving it, and borrowers getting funds at comparatively low interest rates.
4. It typically uses an online platform where the borrowers and lenders register themselves. Due diligence is carried out before allowing the parties to participate in any lending or borrowing activity.
5. All P2P platforms will now be considered non-banking financial companies and regulated by the RBI.

How peer to peer lending works?

Firstly, decide on how much you wish to lend, and for how long. The investors’ funds could be tied up for up to 5 years, so it’s important to be comfortable with this timescale. Remember, you are lending to those wishing to borrow, and 1-5 year loans are the norm.

Some companies offer the option to withdraw your funds during the loan term. There may be a cost for doing this and you’ll have to wait until another lender comes in to replace you, but it is there should you need it. Ideally though, you want to avoid doing this, as you’ll lose out on the great rate of return.

Operation model in India:

P2P lending platforms are largely tech companies registered under the Companies Act. Once the borrowers and lenders register themselves on the website, due diligence is carried out by the platform and those found acceptable are allowed to participate in lending/borrowing activity.

The companies often follow a reverse auction model in which the lenders bid for a borrower’s loan proposal and the borrower has the freedom to either accept or reject the offer.

Some platforms provide several additional services like credit assessment, recovery etc. In most cases, the platform moderates the interaction between the borrower and the lender.

Regulation in India:

Although nascent in India and not significant in value yet, the potential benefits that P2P lending promises to various stakeholders (to the borrowers, lenders, agencies etc.) and its associated risks to the financial system are too important to be ignored, according to RBI.

Documentation:

P2P platforms leverage metrics such as credit scores and social media activity to link borrowers and lenders at favourable interest rates. At present, such platforms have very low regulatory restrictions because they merely act as intermediaries between borrower, lender, and partner bank.

The documentation for the lending and borrowing arrangement is facilitated by the P2P platform. The lender transfers money from his/her bank account to borrower’s bank account. The platform facilitates collection of post-dated cheques from the borrower in the name of the lender as a proxy for repayment of the loan.

The P2P forum, in general, also helps in the recovery process and as part of this, follows up for repayments and if need be, employs recovery agents too.

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