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The Industry still struggles to adjust to the Reserve Bank of India’s (RBI) new peer-to-peer (P2P) lending regulations.
P2P lending is the process where individuals or businesses borrow directly from other individuals without traditional financial institutions acting as intermediaries.
Transactions in P2P lending mainly occur through online platforms that connect lenders with potential borrowers.
It offers secured and unsecured loans, and unsecured personal loans are more prevalent.
Application Process: Firstly, an online application on the P2P platform is done.
Assessment: The application assesses risk, and the borrower’s credit rating is determined and based on this, the interest rate is determined.
Approval: Approved borrowers receive loan offers from investors based on their credit rating and interest rates. The platform charges fees to both borrowers and investors to facilitate the transaction.
Repayment: Borrowers then make periodic interest payments and repay the principal at maturity.
Only Non-Banking Financial Companies (NBFCs) can engage in P2P lending.
All existing and new NBFCs engaged in P2P lending must secure a Certificate of Registration (CoR) from RBI.
All P2P platforms must have a minimum net-owned fund of INR 2 crore.
Platforms must be incorporated in India, and a robust IT infrastructure must be built to ensure secure operations.
The proposed Directors or shareholders of the P2P Platforms must declare that no criminal convictions or pending cases have been there against them.
Higher Returns: Investors in the P2P lending platforms often earn higher returns than traditional investment options.
Accessibility: The P2P lending platform funds borrowers who may not qualify for conventional loans due to low credit ratings or unique loan purposes.
Lower Interest Rates: These platforms generally provide borrowers loans at lower interest rates and origination fees.
Credit Risk: Peer-to-peer lending generally has a high risk of default as many borrowers have low credit ratings, which leads to potential losses for lenders.
Lack of Insurance: There is no government insurance or protection for lenders such type of lending in the event of borrower default.
Legislative Restrictions: P2P lending may be restricted or regulated differently across different jurisdictions, which limits its availability for some borrowers and lenders.
According to the Cambridge Centre for Alternative Finance, the P2P Lending Market in India had a value of 9.60 billion dollars in 2023, and This is projected to grow with a 21.66% CAGR through 2029
In Q4 of 2022, P2P platforms lent over 105 million USD to Small and medium enterprises in India, compared to $80 million from traditional banks.
The real estate sector is projected to grow in P2P at a 25.7% CAGR between 2021 and 2026) and it is driven by the need for developers for accessible funding.
On October 4, 2017, RBI introduced guidelines for P2P lending following the global regulatory practices in the UK, USA, China, and Australia.
T+1 settlement process: RBI’s new regulations mandate that the funds must be transferred within one business day (T+1).
Two-layer loan disbursement: The lenders must transfer funds into an escrow account before disbursement to borrowers.
Prohibition of Lender-to-Lender Transactions: Lenders can no longer engage in secondary market transactions, liquidity and pre-maturity withdrawal options.
RBI Compliance: By strictly adhering to the updated RBI guidelines, Peer-to-peer funds must move directly between lender and borrower accounts.
However, regulations have significantly impacted P2P platforms, leading to their downfall.
Business Decline: Many P2P lending platforms have reported a significant decrease in business volumes, with some experiencing drops of up to 90%.
Operational Viability: Increased operational costs and reduced transaction efficiency in P2P lending cause some platforms to cease operations.
Complication in New Transaction Rules: RBI mandates that funds must be transferred within one business day (T+1), which has again complicated the traditional P2P lending model, which provided flexibility.
Increased transaction Costs: The need for multiple transactions for each borrower leads to higher transaction costs, affecting profitability.
Higher Borrowing Costs: The requirement for T+1 fund transfers has increased the annual percentage rate (APR) for loans, which made them less competitive. APR is the yearly interest rate charged to borrowers, expressed as a percentage and represents the total cost of borrowing money over a loan or investment life.
Escrow Account: As per the new regulation, the lenders must transfer funds into an escrow account before disbursement to borrowers. This will add new layers to the transaction process.
Flexibility: Strong regulatory oversight with flexibility will help build trust in P2P platforms and encourage more participation from both lenders and borrowers.
Standardization: Regulations should promote standardized risk assessment and management practices to enable the credibility of the P2P lending sector.
Enhanced Security: Technologies like blockchain can improve transaction security and transparency, reduce fraud and ensure data integrity.
Smart Contracts: Automated intelligent contracts can be promoted to facilitate seamless loan disbursements and repayments. This will also reduce the operational costs and errors.
Important articles for reference
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PRACTICE QUESTION Q.Discuss the regulatory frameworks for the peer to peer lending in India, highlighting the challenges faced by the sector.(150 words) |
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