In just seven years, the Chinese Peer to Peer (P2P) industry emerged as the largest in the world, with 3,000 P2P platforms with lending book of around $500 billion.
Even as the success of China's P2P lenders inspired entrepreneurs globally to follow suit, the past year has been extremely challenging for Chinese P2P lenders.
Fed up with indiscriminate growth, instances of fund mismatch, governance issues, frauds, and some platforms even running as Ponzi schemes, Chinese regulators clamped down with stiff regulations. The new regulations are restricting the growth of P2P platforms in China, now.
The Unregulated Days
Closer home, the Reserve Bank of India, or RBI, released the regulatory framework for P2P platforms last October. India is also witnessing a ripple effect in the industry, similar to what was seen in China. Though the domestic P2P platform business is much smaller, it does hold huge potential since a large chunk of the population is not served by traditional banks.
When the RBI guidelines came in last year, there were close to two dozen players operating as technology companies registered under the Companies Act.
Three years back when P2P players started in India, there were no guidelines, and different models emerged. A pure, unsecured lending model where lenders extended money for deployment as unsecured personal loans. Another where players offered guarantees (including principal protection) to lenders for routing funds for lending under the platform. A third, where promoters or other shareholders brought in equity and other funds for P2P lending using their own balance sheets.
At that time, there was no restriction on the amount that lenders and borrowers could contribute or avail under the platform. Lending ranged from Rs 50,000 to a crore.
Most investors were small NBFCs, high net worth individuals, or traders looking for high returns; and the borrowers were getting any amount they wanted with no limits. Many platforms were lending to SMEs and MSMEs that were in urgent need of funds.
Life After Regulation
After the RBI guidelines, there is finally some clarity on what defines a P2P - it can only be run after securing an NBFC licence from the RBI - run strictly as a business of unsecured lending. A lender can contribute a maximum of Rs 10 lakh. A borrower cannot take more than Rs 50,000 from a single lender but can take a maximum of Rs 10 lakh spread across 20 lenders. (See RBIs P2P Guidelines).
This makes P2P lending more difficult and complex. "You have to lend to multiple borrowers from a single lender on a continuous basis. This needs a different set of skills at the backend including a technology platform and operational expertise," says Rajat Gandhi, the founder and CEO of Faircent.com that stakes claim to being India's largest P2P.
Several promoters said the RBI's stipulated IT infrastructure is something that a `500 crore plus NBFC requires. For P2Ps, the minimum net owned funds limit has been set at Rs 2 crore.
Most P2Ps can't afford to set up a network at these prices. In addition, the stiff prudential requirements are forcing existing players to abort plans or are forcing existing players to stay away from taking licences. Only 15-odd companies applied. Those that dealt with community lending or chit fund kind of activity have decided to stay away for now.
Getting money will be a challenge now with the restriction of Rs 10 lakh for investors lending to P2Ps. Players in this sector will have to reach out to more investors.
And while P2P players are eyeing mutual fund investors as potential lenders, banking experts say there are trust issues because many P2P players are unknown brands and lack institutional back-up mechanisms.
The mutual fund industry took decades to secure investor confidence and P2P is the new kid on the block. But players say there's no dearth of lenders. "Investor education is the need of the hour. We also have the RBI registration, which serves as a comfort factor for lenders/ investors," says Founder and CEO of LenDenClub, Bhavin Patel.
Pramod Kumar Akhramka, Founder of platform OMLP2P, says it would initially be the ability of the platform to attract funds from the market. If P2Ps deliver the promised returns, then funds would come later. As far as borrowers go, there is no dearth as long as there are companies willing to lend.
There is a huge segment of borrowers - first time salaried class (people with salaries of Rs 5,000 to Rs 15,000) neglected by SMEs, MSMEs and the banking sector. Small borrowers are not served properly, says Surendra Kumar Jalan of OMLP2P. Citing the advantage of lower costs (while the banking sector pays huge regulatory costs), Jalan says the challenge is finding the right borrowers.
Meanwhile, P2P players, responsible for KYC, will need strong management teams backed by bankers, a good board, and systems and processes geared towards success. They'll have to write the right loans so that they don't need to chase borrowers for recovery of funds.
Post 2008, many NBFCs shut shop because of small ticket, unsecured loans; and larger NBFCs like CitiFinancial and Fullerton had to change their business model. The biggest risk for P2Ps is the product concentration in unsecured personal loans. In addition, the cost of operations in dealing with low-cost loans is very high. That is one of the reasons why banks and NBFCs stay away from such loans. However, P2P players reduce costs greatly by using technology.
Tomorrow if volumes grow, the cost also reduces. Banker say physical recovery is the biggest limitation. Funds monitoring (in case of a default or late payment) requires a bank-type physical network of branches in district, talukas, and villages. "We are looking at appointing agents or a partner kind of model all over the country," said one P2P player.
The most comforting factor is the mandatory sharing of credit information by P2P players with credit bureaus. "Earlier, there was no requirement for P2P players to share information with credit bureaus, but now this has been mandated by the RBI. Naturally this will lead to developing a healthy credit culture," opines Rajiv Ranjan, Founder of Paisadukaan, the first P2P player to get licence under RBIs new guidelines.
While P2P players say they are not accepting any bank like deposits and lenders/ investors who have risk appetite are ready to lend to risky customers in the market, there is no risk to the financial stability of the financial market should something go wrong.
In India, the defaults rate is 5-6 per cent, but the size is also small. China, with biggest P2P lending, has seen instances of frauds, fund mismatches, and also governance issues.
Experts admit that India can see higher defaults if we scale up and the economy also sees some challenges - higher interest rates, lower growth and so on. Plus, this is a system with linkages to India's financial system. The RBI is going to watch the P2P platform very closely.