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P2P Lending : a high-return high-risk debt investment product

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. Peer-to-peer lending brings borrowers and investors together on the same websites. Commonly known as “P2P”, it’s an arrangement that “cuts out the middleman”, more commonly known as the banker.

All P2P platforms will now be considered non-banking financial companies and regulated by the RBI. 
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. 
The main idea is savers getting higher interest by lending out their money instead of saving it, and borrowers getting funds at competitive interest rates without too much difficulties.

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. Credit grades are determined by the credit score and credit profile as well as by borrower’s income. The platforms also charge registration fee and/or a percentage of the loan amount that one is borrowing.

 ‘Invest in peer to peer lending in India. Earn up to 35 per cent returns.’ You might have come across the claim at least once or twice during the recent times. Did you wonder: Really, can one actually earn double-digit returns by lending money online? 

Well, P2P loans is an innovative way to invest your surplus money and earn monthly cash flow. But the lending and borrowing eco system comes with the risk of default. 

Here’s a list of five things you should know before planning to lend on P2P. 

Start small 
Don’t let greed cloud your judgment. If you are in a tearing hurry to pocket double-digit returns, you are likely to overlook many warnings signs. That is why it is always better to start with a small amount, learn the ropes, before going for the kill. 

Different platforms have different ticket size for lending, with companies offering as low as Rs 750 per loan and as high as Rs. 50,000 (or maybe even higher) per loan. The ROI would vary as per the borrower profile and loan tenure. The total amount invested by a lender across all P2P-NBFCs is capped at Rs 10 lakh, as per the existing RBI norms. 

One can put part of his portfolio in P2P lending depending upon his investment risk profile. Lend small amounts over short period of time to start with and diversify among various borrowers.

The RBI has come out with regulations for P2P companies. There are around 30 online P2P companies in India, of which only eight have received a certificate of registration (CoR) from the RBI to carry out P2P lending activities. 

Most of the P2P companies believe that the lender should not be in a hurry to take the money out but wait for a good three to six months for his money to deliver results. 

Some advise that if one (lender) has a principal amount of Rs 1 lakh and is earning an interest of Rs 30,000 on it, then put the principal back and rotate his funds for better return.

One P2P lending platform which was a loan aggregator before getting the P2P licence, has a repeat borrower base of 30-35 per cent. As a lender, it’s important to diversify the money into different platforms.

A P2P loan approval may take up to five days with some P2P companies offering facilities like same-day loan approval. However, it’s advisable to understand the nitty-gritties before starting out big on the platform. 

Every financial instrument requires some understanding. Do your research before you get into it. It’s better to compare the various platforms and learn about P2P lending before investing bigger amounts of money.

The amount invested should be carefully divided among different platforms and spread thoughtfully among the borrowers. 

Diversification
You should try to spread out your money among multiple borrowers. Diversification is the biggest remedy to mitigate risks while lending on P2P. If you can take some risk, Rs 25,000 to Rs 50,000 per month can be invested to get up to 35 per cent return annually says a P2P lender.

One needs to look at the average return offered by various platforms to diversify the portfolio well. 

One should have good number of borrowers in one portfolio. Also, invest the money every month instead of putting everything in lump sum. There could be good borrowers coming every month. Don’t get greedy just because you see a higher interest rate (30 percent returns) in a portfolio. It may have a higher risk.
 
Borrower profile 
Most P2P companies divide the borrowers in categories like very low risk, low risk, moderate risk to high risk and very high risk profiles. The ROI on the investment would depend on the borrower profile, tenure and the amount of loan. Companies offer interest rates starting from 12.5 per cent to 35 per cent based on the level of risk. 

Evaluating the risk profiles of borrowers is important to diversify the portfolio. One can go for moderate to low risk profiles for a decent return.

One can diversify by lending to different risk profile borrowers. If you have Rs 100, you can invest 25-30 per cent in low risk, 50-60 per cent in moderate risk and 10 per cent or less in high risk profiles. 

P2P is an alternative asset class which has its own value and potential. One should invest according to his risk appetite.

Lending to unrated and high risk borrowers may not always give high returns, as the possibility of a default is higher in this segment. 

If one is chasing only higher returns, without checking the profile of the borrowers and the credentials of the platform, one might end up burning his fingers.

Some of the P2P platforms boast of stringent criteria for selecting the borrowers in order to control defaults. Out of 40,000 applications received, hardly 1,500-2,000 people go live on the site post the verification according to one of the P2P lending platform CEO.

People with a low repaying capacity, past record of default reflected in their CIBIL data are more likely to get rejected on the platform. It’s also crucial to check the income to debt ratio while selecting the borrower. 

Defaulter rate 
Defaulter rate reflects the ratio of defaulters on a given platform and is vital in choosing the company. The defaults could be due to intentional or capability issues of the borrower. It’s advisable to check if the company has displayed the defaulter rate explicitly on its website. 

People choose a platform based on the credentials of the company. Reputational risk is much higher than anything else for P2P companies. Remember, the ROI would depend on the profile of the borrower. And the quality of borrowers would define the default rate on a platform. 

In a fast growing sector like P2P lending, companies with RBI licences may have an extra edge over the newer players. 

Experience of platform players
With the RBI regulation in place for P2P lending, the older players are better placed than the newer ones (which are yet to get the licence). However, there is no meaningful competition among the companies since all are still at an initial stage.

Vintage is important for lenders. Companies that started early would be able to display more data and would have a better credit evaluation mechanism.

Companies that have already applied for licences will get it in next two to three months. P2P players with good credit evaluation of the borrower and the lowest default rate will eventually succeed.

The quality of loan and the quality of the portfolio will decide the growth of the company. If the lenders make money, they will come back on the platform. If they don’t, they will not.

Reference: TOI
Atul Mishra CFPCM, CWM, MFP, CII(Award), DipCISI
SEBI Registered Investment Adviser
(Registration No. INA000004245)
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