P2P lending forms part of the emerging FinTech revolution enabled by a strong digital foundation leading to disruption of the traditional players like Banks.
Globally, Peer-to-Peer lending or P2P lending is a decade old industry. Key players include:
USA: Lending Club, Prosper,
UK: Funding Circle, Zopa
China: PPDai, Renrendai, Lufax, and
New Zealand: Harmoney
However in India, it is a quite a new and emerging industry. As per Reserve Bank of India (RBI), it is noted that more than 30 platforms / start-ups are working to fulfill the credit needs of individuals, students and small businesses.
P2P lending industry is in a similar development phase as Debt Mutual fund industry of early 1990’s when the regulations were emerging. Consumer awareness was low for Debt Mutual Funds & people preferred to keep money in Fixed Deposits with banks.
To help you make a smart choice, we at Monexo are creating these education blogs. As you consider, P2P lending in your investment portfolio, ask these questions to the platform:
1. Founders Experience in Financial Services:
The heart of P2P lending is about Credit Screening and Risk assessment. The founders have to bring this expertise into the young organization. If the founders have not worked in Banks for at least 10+ years most likely they have not got an experience managing credit screening and risk assessment.
As young company, the founders experience is the real age of the company. For example, at Monexo we have 70+ years of Consumer Banking experience with Credit screening and Risk assessment.
2. Participation in Credit Bureau:
Continuing with Credit Screening and Risk assessment process – you as a lender are taking the risk of default of the loan. The RBI draft consultation paper clearly articulates the platforms cannot give any ‘guarantees’.
Credit Bureau came to India in 2008. Since then 4 Credit Bureaus have emerged in India – CIBIL, CRIF Highmark, Equifax and Experian with CIBIL being the most popular. However, one should note that as per RBI guidelines all Banks and NBFC’s are required to report all loans disbursed and repayment behavior to all the 4 Credit Bureaus on monthly basis.
Once the financial institution report the loan to the Credit Bureau, it acts as a notice to all other financial institution of the indebtedness and repayment behavior of the borrower for their credit assessment.
High quantum of loan or bad repayment behavior by the borrower leads to higher pricing as well as could lead to no further credit availability from the financial institutions. This Credit Bureau reporting has lead to borrowers paying on time to maintain a good credit record.
If the P2P lending platform does not report the loan in the credit bureau, the borrowers true picture of indebtedness is not available and they would go ahead and provide more credit. Also, as the borrower would like to keep his credit record clean he / she will have higher incentive to pay the financial institutions that report the loan in the Credit Bureau.
Monexo is the only P2P Lending platform that reports the loan disbursement and repayment behavior to the Credit Bureau. This leads to better Credit behavior of the borrowers on Monexo and lower risk to the lenders on Monexo.
3. Flow of Money between Lenders and Borrowers and vice-versa:
RBI draft guidelines are clear that P2P Lending platforms cannot take deposit or handle the money of borrowers or lenders.
This has lead to quite a few Indian P2P lending platforms to request lenders to send money to borrowers through NEFT /RTGS / IMPS directly to borrowers. They also request the borrowers to issue cheques to lenders in proportion of the lending amount.
This leads to:
• Too much work for lenders managing the monthly repayment themselves,
• Borrowers have to receive too many small credits and track whether they have got all the borrowing amount unlike a bank where they get a single credit to their bank account,
• Too many cheques to be written by borrower in favor of the lenders,
• Lenders NOT participating in risk on pari-pasu basis,
• P2P platform has NO ongoing understanding of loan default till a lender reports.
At Monexo, we have solved this by partnering with IDBI Trustee who act as escrow account service provider to lenders. Monexo does not get access to lenders funds but is able to give single credit to borrower, collect a single repayment from borrower and provide pari-pasu risk participation to all lenders in case of short payment.
4. What happens if the P2P lending platform shuts-down:
Loans given by the banks are typically of 6 to 60 months and this holds true for P2P lenders too. What happens if the P2P lending platform shuts down after 9 months of operation and you have made 100 loans?
RBI, to protect lenders from this risk has clearly specified a need for ‘living will’ in the draft P2P consultation paper of April 2016.
Living will is to be created by the P2P platform for the circumstance when the P2P lending platform is unable to continue operation due to lack of funding / working capital or lack of profits thus making the operation unviable for founders and its team.
Some platforms may say that you are already holding the Post Dated Cheques and are aware of the borrower identity thus as a lender you can follow up with the borrowers if they shut-sown. Well that might work however you as lender already have a full-time job or occupation. This is too onerous for you and neither do you have an expertise or experience in dealing with these situations.
Once again, as a responsible and a leader in the industry Monexo has created a structure with IDBI Trustee where the Trustee will continue to provide the repayment collection service to you and return the un-invested amount immediately.
5. Pricing / Interest charge for the Loan – each borrower has a different risk profile and it requires suitable pricing
Pricing a loan is a science. Over the years, banks have built robust models after understanding risks of non-payment, probability of default based on the loans they have made in the market.
Concepts like ‘risk based pricing’ means that higher the risk of default, higher should be the pricing of the loan.
An individual do not have these data, tools or expertise to come out with this pricing.
However, as Monexo founders come from the Consumer Financial services in India they have worked extensively and built these models at the bank and have replicated those best practices on the platform. Each loan on Monexo is graded into any of the 8 categories of rating – M1 to M8. Grade M1 is the best borrower with lowest probability of default. With each grade thereafter the probability of default increases and M8 has the highest probability of default. You can read more in our FAQ section about them.
P2P lending is ‘democratizing’ finance with far reaching and positive impact to the society at large if done properly. Monexo is bringing the best practices from Banks; Global P2P players; Digital Data based screening and Data Science to you to invest in P2P lending.
As you evaluate P2P lending as your next investment, do ask these questions and choose the platform wisely.