Internet is causing rapid changes in way to do businesses giving emergence to online industries.. Peer to peer (P2P) lending is one of the changes that has gathered attention globally and is expanding in India. P2P lending falls within the domain of a bank. Peer to peer lenders are also known as market place lenders.
What is Peer to Peer Lending and what is its Business model?
Peer to peer lending is a type of crowd funding used to raise loans which are paid back with interest. It mainly involves borrower,an online platform, and the lender.
Alternatively, it can be defined as the use of an online platform that matches lenders with borrowers in order to provide unsecured loans. The interest rate may be set by the platform or by mutual agreement between the borrower and the lender. Fees can be paid to the platform by both the lender as well as the borrower.
The borrowers pay an origination fee according to their risk category. The lenders, depending on the terms of the platform, pays an agreed fee. The platform provides the service of collecting loan repayments and doing preliminary assessment on the borrower’s creditworthiness. The fees go towards the cost of these services as well as the general business costs.
The platforms do the credit scoring, credit worthiness analysis and make a profit from the arrangement fees and not from the spread between lending and deposit rates as is the case with normal financial intermediation. One of the main advantages of P2P lending for borrowers has been lower rates than those offered by money lenders or unorganized sector and the advantage for lenders is higher returns than what conventional investment opportunities offer.
Peer to Peer Lending in India
In India, there are around 30 start-up online P2P lending platforms. They have similar activities as micro finance activities with the stated primary goal being social impact and providing easier access of credit to small entrepreneurs. They provide web-based platform to bring the lenders and the borrowers together. These market place lenders may charge interest rates ranging from a flat interest rate fixed by the platform or dynamic interest rates as agreed upon by the borrowers and the lenders based on cost effective model.
In India Marketplace lending platforms are largely technology companies acting as an aggregator for lenders and borrowers creating a match between them. Borrowers and lenders registers themselves on platform then market place lenders scrutinize their application, after approval they are allowed to participate in the process.
In this business model they 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. The platform moderates the interaction between the borrower and the lender. Some platforms also provide several additional services like credit assessment, recovery etc. The documentation for the lending and borrowing arrangement is facilitated by the online platform. The lender transfers money from its bank account to borrower’s bank account. Market place lenders also helps in the recovery process and as part of this, follows up for repayments.
Peer to Peer Lending Globally
As of December 2015 peer to peer lending activity cumulatively reached to GBP 4.4 billion it has jumped from GBP 2.2 million within 3 years,2012.
In China, Ecuador, Egypt, South Korea, Tunisia its exempt market as there is a lack of definition in legislation. In Australia, Argentina, Canada (Ontario), New Zealand, United Kingdom it is termed as as an intermediary. In France, Germany, Italy, it is termed as Banks. In United States of America, it is regulated by SEC and FED. P2P lending is banned in Israel and Japan. In India market place can be regulated by RBI if they adopt company structure.
Risks involved in P2P lending
Like other lending business it also has credit risk but level is comparatively high. As borrowers and lenders depend on online platforms there can be information asymmetry incentives. Moral hazard and adverse selection problem intensity could be higher.
Clear guidance and regulation can make peer to peer lending business attractive in future, even traditional banks can adopt this approach.