Can Peer to Peer Lending Work for You?

Earlier this month, Fi, a neobank, announced it would offer its customers P2P lending with returns of up to 9%. Fi is just the latest fintech player to enter this space. From August to September 2021, two other firms – Bharatpe and Cred – made similar announcements about launching P2P lending.

P2P or peer-to-peer lending is a digital platform that aggregates borrowers and lenders and essentially fulfills the role of a bank. Because the process eliminates the role of a middleman, P2P allows lenders to earn a slightly higher rate of return than bank FDs. Interestingly, a message on Bharatpe’s 12% Club app states that it will “reopen soon” for new investment while existing investors will continue to receive repayments. In general, fintechs allow investors to access their money either within a few hours or within 1-2 business days. This is made possible by holding a certain amount as a buffer and betting that not all investors will return their money at once.

“CRED Mint has no fixed lock-up periods and offers members liquidity through our marketplace, allowing them to request instant withdrawals after 7 days and earn interest for the duration saved,” said a CRED spokesperson.

P2P lending is regulated by the Reserve Bank of India. Only Non-Banking Financial Companies (NBFCs) that have a P2P license can issue such loans. Fintechs generally partner up with NBFCs like LenDenClub or Liquiloans. The maximum term of this type of loan is 36 months. You can lend a maximum 50 lakh on all P2P platforms. People who lend more than 10 lakh in P2P must show a certificate of wealth of more than 50 lakh from an accountant. However, an investor’s exposure to a single borrower must not be exceeded 50,000.

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How it works

P2P loans are personal loans and typically earn an interest rate of 20-24%. These types of loans are taken out by individuals for purposes such as investing in their business, renovating their homes, or family expenses such as marriage. Borrowers are usually self-employed or employees in the unorganized sector, as employees in large companies can usually get personal loans from banks at lower interest rates. Of the interest earned on loans, a certain percentage is retained by the P2P platform (NBFC) and the fintech platform, with the balance being left to the investor. In Bharatpe this amount is given as 12%, in Cred and Fi as 9%. Platforms like Fi and CRED say they are filtering out lower-quality borrowers from the P2P platforms’ borrower base. Therefore, the investor return is also lower. “Money invested in CRED Mint is lent to the trusted CRED member community through CRED Cash, a CRED lending product. All CRED members have a credit rating of 750+. Members benefit from the elimination of commissions, inefficiencies and other overheads that eat away at typical returns, resulting in higher returns in the process,” said the CRED spokesperson.

As a P2P investor, your returns depend on this simple calculation that won’t go wrong due to mounting defaults. P2P lending portfolios have rates of NPAs or distressed assets. As long as the NPAs can be absorbed by the NBFC or fintech within the spread (the difference between the lending rate and the borrowing rate), investors’ returns will not be hurt. According to Liquiloans’ website, gross non-performing assets accounted for 0.4% of the portfolio as of March 31, 2021. This peaked at 0.6% in September 2020. For Lendenclub, the website states a failure rate of 3.48%. This peaked at 5.86% in the first quarter of fiscal 2021. The very different risk representations indicate the lack of a uniform calculation method. Liquiloans’ website further suggests that the NPA rate must be read cumulatively — over a credit cycle. For example, if the NPA rate is 5% for 1 quarter and the credit cycle is 2 quarters, you should subtract 10% from your return. “The default rate for loans originated through CRED Cash has historically been less than 1%, the lowest of any existing loan originator. The money will also be distributed among more than 200 borrowers to diversify and reduce risk,” added the CRED spokesperson.

P2P platforms consider the risk to be manageable despite the high level of interest rates. According to LenDenClub CEO Bhavin Patel, P2P platforms source borrowers from a variety of places, including their own websites and apps, as well as other digital apps. The interest rate of 20-24% is only slightly higher than NBFCs, he added. “It does not follow that such borrowers are vulnerable to default. P2P borrowers are generally small ticket size borrowers. Our average ticket size is approx 20,000. Such borrowers are interest rate sensitive. Rather, they focus on the absolute amount they have to pay back. For example 24% on a loan from 20,000 is 400, an amount that borrowers don’t think is onerous,” he said. However, as an investor, it remains a high-risk product. If you’re still interested in dipping your toes, limit it to a small portion of your portfolio.

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