Peer to Peer Lending – Whats it all about?

39-year old Karan works at a senior level in a media company. With the intention to beat inflation, he has been investing his surplus funds in various market-based investment opportunities for the last 14 years. With some guidance from a financial expert, Karan has managed to build a good financial portfolio across MFs, SIPs, gold, commodity and real estate. While the stock market crash of 2000 and 2008 coupled with recessionary trends in real estate and gold over the last 2-4 years have hit returns from his portfolio, he understands that risk-based investments require a long-term horizon. Karan, is always on the look-out for alternative investment opportunities that yield better returns over traditional savings and deposits. That’s when he heard about (Peer-to-Peer) P2P lending.

Just over a decade ago, slowly and steadily, a financial revolution started mainly in US and UK which was soon to spread across the globe. P2P lending was making a debut and leaving its mark. Zopa (UK) was the first P2P Lender established in 2005 followed by Lending Club and Prosper (2006-2007) in US. Since then, cumulative lending through P2P platforms has grown from $2.2bn in 2012 to $44bn in 2015. JP Morgan has partnered with OnDeck Capital while banks like Silicon Valley Bank, BBVA and Credit Suisse are investing in the funding rounds of different P2P lending sites. In India, 20 players debuted in just 2015.

So, what is P2P lending and how does it qualify as an asset class? Traditionally, banks and other financial institutions, on savings accounts or fixed deposits offer interest rates of say around 4-7% on surplus funds invested with them. They lend out the same money to borrowers as personal loans at 15-36% keeping the margins as their cost.

P2P lending brings borrowers and lenders directly in contact with each other thereby removing intermediaries like banks and other financial institutions. Thus, the margins kept by the intermediaries are passed on to the end users. Hence, borrowers can avail personal loans at lower interest rates and lenders can earn higher returns on their surplus funds. For egs on Faircent.com borrowers can avail personal loans starting at 12% and lenders are earning 18-22% p.a return, risk-adjusted.

P2P lending is a risk-based investment and these returns are subject to the lenders investing smartly. The inherent risk that exists is that the borrower defaults. Thus, understanding the borrower is extremely important. After all, he is the person you are handing over your money to. He is the one who is going to not just pay back your money (principal) but also the return on that money (interest).

A credible P2P platform will invest heavily on ensuring that only the most genuine borrowers and their requirements are listed on the website. Each and every borrower should be evaluated across data points – personal, financial and social – and on various parameters to understand their ability, stability and intent to pay. A thorough verification process including physical verification and use of a fully-automated underwriting mechanism helps. The buck doesn’t stop at listing. Even post agreement and disbursal, the P2P lending platform should manage risk through legally-binding loan agreements, diligent collection procedure, and effective recovery process (in case of default). Thus, before choosing a P2P lending market place, an investor must evaluate their underwriting process, their risk-management team and practices.

P2P lending has another benefit. It not only provides an opportunity to the investor to earn like a bank but also to feel-good by helping a fellow Indian to consolidate his debt, get his home renovated, child married, buy a car or two-wheeler or expand his business. More than 25% loans are for debt consolidation taken from various sources including credit card overdraft, followed by business funding, home improvement, family events like marriage, medical emergency etc.

By providing higher returns and liquidity, P2P lending is slowly eating into the share of other investment opportunities and smart investors are making the most of it. This most disruptive, financial innovation of modern times is here to stay!

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