A Bridge Over The Lending Gap

"Online P2P lending has emerged as a powerful source of alternative credit in India, especially for MSMEs."

Illustration by Ajay Thakuri Illustration by Ajay Thakuri

Traditionally, people have borrowed money from friends, family or even money lenders. But technology has changed that. Access to financial services has been democratised to such an extent that today the role of modern finance is largely a result of tech-driven innovation and disruption. However, unfortunately, availability of institutional credit in India remains limited, largely due to the formal banking sector's restrictive lending policies and their low coverage. This is where technology has been able to play an important role and the concept of peer-to-peer (P2P) lending has upended an entire sector.

Online P2P lending has emerged as a powerful source of alternative credit. While the concept may not have originated in India, the model has been tweaked sufficiently to take care of India-specific issues.

One aspect of borrowing, which has been a serious ailment, is that people are not aware of products, schemes and even how to take a loan from a bank. Traditionally, financial institutions had little incentive to educate the masses and in most cases it was economically prohibitive and time consuming. Technology has changed this - a search engine has the power to alter the way we access any information on the Internet. It is heartening to see that within a short span of time, P2P lending has spread across the country and is not limited to only the metro cities.

Indians across urban as well as rural regions are increasingly capitalising on technology to access core banking services. The ubiquitous mobile phone and spread of Internet has ensured this growth, and in its tailwind fintech products have emerged strong. Retail consumers as well MSMEs are affected by restrictive lending policies of banks and financial institutions due to the absence of a credit or banking history. For a majority of MSMEs, particularly those operating in smaller locations, business is undertaken mostly in cash. As a result, most of them have minimal documentary evidence of their business and a limited banking profile, which hinders their ability to avail institutional credit.

Former Deputy Governor of RBI, S.S. Mundra had said in a speech: "Lenders need to be mindful that MSME is a vast universe comprising of several million micro enterprises without an elaborate system of account-keeping. Hence, standard ratio analysis would be an ineffective mode while appraising their credit proposals...the banks would need to look to assess their credit worthiness under a credit scoring model using unconventional matrix comprising of utility bill payments, remittance history, etc."

The P2P lending model is more conducive to the needs of various categories of borrowers. P2P lending platforms employ artificial intelligence (AI) and automation, with data analytics, machine learning, and predictive modelling to process large amounts of raw data on borrowers, and derive insights for efficient and accurate credit underwriting. The algorithm-based underwriting process assesses a borrower's creditworthiness, and then provides a variety of loan offers. The borrower provides basic financial information online, based on which lenders decide whether they want to invest in a borrower or not. Thus, by eliminating intermediaries and their incremental margins, borrowers can access credit at lower costs and lenders can make higher returns.

Global & Indian experience

The entry of new players, rising demand for alternative credit from borrowers, and consolidation of market share by larger players in some countries led to the respective governments taking necessary steps to regulate P2P lending. As a result, P2P lending has become a large and fast-growing industry competing with the traditional banking sector, and also emerged as a viable credit source for borrowers and a lucrative instrument for investors. The P2P lending industry valued at $3.5 billion globally in 2013 and at $64 billion in 2015 is expected to be worth nearly $1 trillion by 2050.

In October 2017, the RBI issued guidelines to regulate P2P lending in India. P2P lending platforms can now operate as NBFC-P2P. This move has not only strengthened the industry's growth prospects but has also helped bring greater trust and transparency for both lenders and borrowers. The guidelines define the regulatory framework within which NBFC-P2P can operate, scope of a P2P lending facilitator's operations and responsibilities, regulations on capital, governance, fund transfer mechanism, data security, among others. Today, there are about seven operational certified NBFC-P2P lending platforms in India with a combined loan book value of nearly $25 million, while the industry itself is expected to reach a value of more than $5 billion by 2025.

According to an ICRA report, the amount of credit provided to the MSME sector was Rs 16 trillion for FY 2017, when the actual unmet demand for credit from the sector was Rs 25 trillion. Being India's second-largest sector in terms of the number of people employed (80 million), MSMEs' ability to grow is seriously hindered due to the lack of funds to grow and scale.

Some advocate the rise of fintech and in particular P2P platforms as an alternate to banks and in fact one day replacing it altogether. This is a narrow view of what can be achieved. Given the unmet needs for institutional finance across India, we should look at P2P and every other fintech tool as a complimentary tool-a-bridge. While talks of bank-less economy may at this stage be a stretch, this disruptive innovation has indeed caught everyone's attention.

The writer is CEO & Founder, Faircent