Why in news?

In August 2024, the Reserve Bank of India (RBI) imposed strict rules on peer-to-peer (P2P) lending platforms. As a result, the industry’s asset under management (AUM) plummeted by 35% — from an estimated ₹10,000 crore to ₹6,500 crore.

The main purpose of P2P platforms is to connect lenders and borrowers, without being directly involved in the loans themselves. There are mixed views on whether P2P platforms can adapt to the changes imposed by RBI. This article explores the sector’s past, present, and possible future.

What’s in today’s article?

• Peer-to-peer (P2P) lending
• Regulation by RBI
• The Uncertain Future of P2P Lending in India

Peer-to-Peer (P2P) Lending

• About
  • 
  • P2P lending is a method of lending money directly to individuals or businesses without a financial institution as an intermediary.
  • This typically occurs through online platforms that connect lenders with borrowers.
  • While P2P loans can be either secured or unsecured, most are unsecured personal loans, with secured loans—usually backed by luxury items—being rare.
  • P2P lending is valued as an alternative financing option due to its distinct characteristics.
• Working
  • Borrower Application: A borrower submits an application on a P2P platform.
  • Risk Assessment: The platform evaluates the borrower's creditworthiness, assigns a risk rating, and sets an interest rate.
  • Investor Matching: Upon approval, the borrower receives loan offers from investors based on their rating and interest rate.
  • Selection: The borrower reviews options and selects a suitable offer.
  • Repayment: The borrower makes regular interest payments and repays the principal at the loan’s maturity.
  • Platform Fees: The platform charges fees to both borrowers and lenders for its services.
• Advantages
  • Higher Returns: P2P lending generally offers investors higher returns than traditional investments.
  • Accessible Funding: It provides a funding option for borrowers who may not qualify for traditional bank loans.
  • Lower Interest Rates: Due to increased competition and lower fees, P2P loans often feature reduced interest rates.
• Disadvantages of Peer-to-Peer Lending
  • Credit Risk: P2P loans carry a higher risk of default since many borrowers have low credit ratings.
  • No Government Protection: Lenders are not insured or protected by government guarantees.
  • Regulatory Limitations: Some regions restrict or heavily regulate P2P lending, limiting access for certain borrowers and investors.
  • Extra charges – Borrowers might encounter additional charges beyond the loan’s interest rate, which can potentially raise the cost of borrowing.

Regulation by RBI

• Early Discussions on Regulating P2P Lending
  • In 2016, RBI began considering regulations for P2P lending to address informal money-lending practices.
  • With global growth in P2P lending and new platforms emerging in India, the RBI released a discussion paper on whether regulation was needed.
  • Concerns included potentially legitimizing P2P lending by regulating it, stifling its growth, and the sector's limited impact on the financial system at the time.
  • After consulting stakeholders, the RBI issued guidelines in 2017 that outlined activities for lenders, set eligibility criteria, and mandated transparency on fees and pricing.
• Regulatory Concerns and Clampdown
  • P2P platforms started behaving like banks by profiting from the difference between borrower interest rates and lender earnings.
  • This led the RBI to intervene, banning practices such as using one lender's funds to replace another's, thus shutting down the secondary market.
  • The RBI's regulations mainly targeted popular features like guaranteed returns based on investment terms and easy withdrawal options, and also required a faster settlement process (T+1).
  • The RBI also required full fee disclosure and prohibited closed-group matching of lenders and borrowers.

The Uncertain Future of P2P Lending in India

• The outlook for P2P lending in India remains unclear.
• A major P2P platform recently halted new customer registrations, resulting in a 30-35% drop in assets under management (AUM).
  • AUM is the total market value of investments that a financial institution, fund manager, or entity manages on behalf of its clients.
• The RBI has been inspecting platforms for compliance, and if secondary market options remain restricted, volumes may decline significantly.
• Some large platforms are even considering relinquishing their licenses.