P2P Lending

In this form of lending, the transaction is done between individuals directly. The amount involved and the terms of payment are mutually agreed upon by the lender and borrower. This is one of the most prevalent forms of lending in the society. The reason for such lending is usually manifold.

  • It could be to earn goodwill from an influential person.
  • It could be to help somebody in distress.
  • It could be for somebody to make a most-desired purchase.
  • It could be done for somebody to earn profits.
  • It could also be done for multiple other reasons.

The profits that lenders make in P2P lending is usually much more than the formal lending system and therefore this type of lending is more popular. P2P lending has traditionally been done through informal mechanisms and is usually not encour-aged by any established lender in the formal lending space. The interest earned on the lending is usually decided upon multiple considerations and the circumstances prevalent for the lender and borrower at the time of the lending or borrowing respectively. Some of the considerations that lenders use to determine what interest rates are to be charged are:

  • The reason for borrowing and its criticality.
  • The duration required by the borrower to return the amount.
  • The potential risk of default by the borrower.

The interest rates thus, are quite variable and in some cases the interest could be multiple times what is being charged in the formal lending system. In some coun-tries, P2P lending as part of an informal system is considered illegal.

Though this is one of the most detested types of lending, it is yet very popular because it ends up providing just-in-time financial support. The reputation of the buyer and lender is the key for any P2P lending to take place. The reputation of either is known through references close to both the lender and borrower. Additionally, information gathered through word-of-mouth also determines the creditworthiness of the borrower, as well as the trustworthiness of the lender to return the mortgaged assets once the loan is repaid. In some cases, the lender physically verifies the mortgaged assets including gold, real estate, etc. before giving the desired financial assistance to the borrower. The recovery by the moneylender for the amount financed in the informal system is usually done in person and in cash. The lenders, in case of difficult or unwilling borrowers, typically employ the services of musclemen to recover the loan. This practice in particular has been criticized for being unethical and a kind of extortion or torture. In most of the humanitarian arguments against this type of lending,

the borrower is considered of less means and it is difficult for him to return the loan taken.

All the above makes P2P lending a multistep, person-dependent and expensive alternative for borrowers. Consequently, P2P lending is usually resorted by borrow-ers when either the avenues for formal lending has been exhausted or denied to the borrower. In some cases, P2P lending is done if the amount involved is small and a large financial institution would not want to get involved in such a low-value trans-action. While there are disadvantages of P2P lending, it is so popular because (1) it provides just-in-time lending, (2) the approval process takes less time, and in some cases, it is instant, (3) since the lender usually knows the borrower, typical borrow-ing prerequisites like KYC, on-boarding, etc. is eliminated, (4) the payment terms are quite flexible, (5) interest rates are quite flexible and (6) decisions like interest rates to be charged, loan tenure, EMI, etc. are taken on a case–by-case basis and usually done within a day itself.

In the last decade, multiple start-ups/FinTechs have brought in P2P lending platforms. These platforms blend the flexibility of informal P2P lending with the transparency and trust of formal lending. These platforms offer multiple features like:

  • The verification of lenders and buyers
  • Maintaining ratings for borrowers and lenders
  • Multiple calculators and auction engines for getting the best deal from a lender/borrower
  • Flexibility in defining the terms of the interest payment on a case-to-case basis
  • Enabling direct online payments and in some cases, direct debits
  • The lending marketplace for borrowers and lenders
  • Credit checks for borrowers
  • In some cases, guaranteed returns in case the borrower defaults
  • Easy to use interfaces for asset and collateral mortgaging
  • Differential interest rates and multiple different types of lending

The following is a summary of some of the ways P2P lending platforms have dis-rupted the lending space by blending the right flexibility with trust and trans-parency through use of technology. Some of these platforms have also introduced innovative ways of P2P lending and therefore, are quite successful and popular.

Most of the P2P lending FinTechs have created an Online marketplace wherein the borrowers and lenders can post details about their borrowing and lending requirements respectively. Then the members of the website can decide to participate in lending or borrowing in response to posts that are available on the site. This translates into potential lenders choosing from a list of borrowers depending on the interest rate offered, grade of the loan and the amount and purpose for borrowing the money. The process starts with borrowers applying for loans. The borrowers can apply for loans only if they meet a certain credit score requirement. Their loan then gets listed on the platform, and investors can browse through all the listed loans. These platforms verify their borrowers through a systematic verification process. Once a borrower is approved/certified, the loan is issued to the borrower if it is fully funded. The loan listed by the borrower stays for a certain specified time, and once it’s approved, gets it within a very short time frame. The borrower then starts repayment of the loan after a certain specific number of days. The payment is principal plus interest on a standard amortization schedule.

In case of some of the P2P lending platforms, all the funds are queued on a first come, first serve (FCFS) basis. The money invested by an individual is then distributed to multiple borrowers at market rate. Therefore, a single investor could be lending to multiple borrowers and a borrower would be borrowing from multiple lenders. Each investor’s investment is typically broken down into chunks of small amounts of the total amount invested. The borrowers are then categorized into a risk market based on various criterion like identity, affordability, employment and credit history. Every time a borrower repays the loan, the platform deducts the invested amount by the EMI paid and adds the interest to the lender account. The money in the lender account thus keeps adding up, which is then reinvested in lending to multiple other borrowers. From a lender’s perspective, they are invest-ing money for a specific duration and at an acceptable interest rate. Therefore, the platform keeps on reinvesting the amount at that acceptable rate.

In the past, P2P lenders have also experimented with the auctioning of loans to investors. The lenders on the basis of the loan amount, interest offered and bor-rower ratings and past history would be participating in the auction process. The auction would additionally drive borrowers and lenders to decide the best common terms of agreement for lending to begin. This mechanism has been quite effective in getting the best interest rates for lenders and borrowers together. Though as a downside the chances of default by borrowers or lenders participating in an auction becomes very high. Since the terms and conditions of the loan also gets negotiated, the auction can go on for a while before the lenders and borrowers agree on certain terms. Consequently, owing to the complexity of processes, many of the P2P lend-ing platforms have moved away from auctioning loans.

Some other platforms cater to personal loans and provide a financial advisory plat-form along with managing loans. They even conduct onsite inspections to verify and recommend borrowers to the platform. There are franchise-based offline P2P lending platforms as well that are becoming popular. These platforms provide loans through offline channels. Some of the platforms are a mix of online and offline platforms. These platforms have partnered with offline lending services to provide offline loans and has a loan protection mechanism like many of the previously discussed platforms. There are other customer to business platforms (C2B). These platforms identify projects and businesses worth investing in, and accordingly facilitate corporate loans through lenders investing in the platform. The business model, unlike inves-tors participating in corporate debts, is actually reversed wherein the corporates instead leverage the investors’ participation by reaching out to them using these platforms. For investors, these platforms offer alternate investment opportunities. Again, most of these platforms are very transparent in projecting their loan books, cash flow statements, etc.

Some P2P platforms enable lending to small businesses and entrepreneurs by creating a pool of money from small contributions of retail lenders. The platforms offer an online marketplace that helps lenders to invest small amounts. The platforms are an online platform wherein the lenders can lend a very small amount. A group of lenders investing small amounts end up creating a big pool of money that can be lent to borrowers for a decent return. Small businessmen and entrepreneurs are the typical borrowers in the marketplace. Before handing over the money to businesses, investors get to the check creditworthiness of the business, financial statements, reasons for the loan and expected returns on the loan. Some of these platforms do a due-diligence of the business before lending out to them and mandates that the business has been operating for a certain specified duration generating reasonable revenue with a prospect of being profitable soon. These platforms assign a rating to all the borrowers in a very transparent manner along with other information to the investors, so that they can evaluate risks and returns accordingly.

Some of these P2P platforms are veering toward getting a banking license and becoming a full-fledged bank, while others are clearly stating that they are not banks. The basic principle behind these P2P firms is the concept of sharing their savings with the borrowers and lenders. This is symbolic of the differentiation that FinTechs are bringing as compared to their established peers. It is also indicative of the transparency and trust FinTechs are bringing into the financial services industry. The platforms, in addition to facilitating lending, are also helping borrowers to get better interest if they have a good credit score. This is in contrast to the approach

of a one size fits all approach of the established lenders. They use the credit score only to qualify or disqualify a borrower, but the interest rate they charge is the same for all the borrowers. Therefore, a good borrower pays the price for the payment not being made by defaulters. Additionally, unlike their established peers, most of the FinTechs do not let a borrower’s credit score get impacted if they apply for a loan or enquire for a loan from them. A large number of P2P firms also publishes the gains made by investors and often provide a comparison of the profits investors would have made while investing in traditional financial instruments from banks and capital markets versus investing in their own platforms.

In P2P lending the chances are high that borrowers would default and therefore it is one of the key performance indicators for any P2P lending platform. Consequently to safeguard their investor’s interest from a borrower’s default, some of the FinTechs introduced a fund or notes. These funds or notes cover the investor’s losses in case the borrowers default. Therefore, lenders are protected from a default risk. Most of the P2P platforms have also started rating the borrowers on a number of criteria before deciding on the rate of interest based on the risk category the borrower falls in. The loan pricing algorithm has therefore become a key factor for the entire system, and lenders have to agree to the terms laid out by the system before they start extending the loans.

These platforms make money by charging fees from borrowers or lenders, and some other platforms charge the fees from both, but the fees are quite nominal as compared to the established banks. Additionally, these platforms allow lenders to start lending from as little as few dollars to millions of dollars by individual lenders and large investment/lending firms. Every time a borrower repays the loan, these exchanges deduct the loan servicing fee for itself, deducts the invested amount by the EMI paid and adds the interest to the lender account. The money in lender accounts thus keeps adding up, which is then reinvested in lending to multiple other borrow-ers. As mentioned earlier, a large number of P2P lending firms are converting their loans into collaterals and derivatives that can be traded in the primary and secondary markets thus creating an additional source of income for themselves and investors.

P2P lending is now being adopted globally, including in China, where around half a trillion dollars worth of loans have been provided through P2P lending platforms. There are multiple platforms in China that have prospered in the last 5–7 years. Some of the P2P lending platforms in China are Tuandai.com, PPDAI. com, Eloancn.com, Touna.cn, Renrendai and Lu.com

Some of these platforms typically work like online exchanges that facilitate information and ratings for borrowers and lenders. These platforms have different interest rate plans based on the grading of the loans. Lenders can invest in them based on their risk capacity. The platforms also have links to social networks as it encourages lending to family and friends. It also relies more on these connections to impose social pressure and to reduce defaults. The most interesting thing about these platforms is they keep flashing the income earned by investors daily/monthly etc. and that drives more new investors to get into the platform.

A large number of P2P firms maintain a complete database of all the loans issued through them on their website. The database is available for analysis by request through the website. This is an entirely different level of transparency exhibited by FinTechs as opposed to large banks, which do not make their loan books available for scrutiny on this level. Consequently, these p2p lending firms have challenged banks by being transparent between lenders and borrowers and the commission it makes as a market place, which is much different from what large banking or lending institutions have to offer. Besides these P2P lenders, there is an ecosystem of data analysis platforms that can help analyze data about customers. The platforms typically include NSRPlatforms, lendingRobot and PeerCube. Some of these platforms even offer advice on how an investor should be investing.

This is a great example of how FinTechs are making inroads into the business functions primarily managed by large banks. Large banks typically do not want to give loans to small businesses as they believe recovery could be high risk. Instead they prefer to invest money in giving loans to moderate and low-risk businesses. Ironically, banks have lost huge sums of money to established businesses, yet they are reluctant to lend to small business. Additionally, owing to their large size, it is very expensive for large banks to evaluate the worth of small businesses and the subsequent servicing of the loans.

From an investor’s perspective, banks (deposit and investment) have catego-rized investors into debt, equity or commodity investors and their hybrid products. There is no place for a low-risk debt investor to make more money by still being a moderate risk taker. This is where these lending platforms have made it simple for these investors and borrowers to come together and make investments on genuine borrowers. Additionally, since the invested amount is further split into fractional amounts across multiple borrowers, the investors make moderately higher returns by taking a fractional risk. This is different from what an investor would have made in a traditional banking or investment set-up. The different variants of P2P platform include:

An aggregator for borrows and lenders and the primary focus is informative. A marketplace for trading to take place between lenders and borrowers

directly.

Invest on behalf of lenders to a specified group or kind of borrowers.

Issue marketable securities on behalf of borrowers to be invested and traded like debt securities.

Post Author: newfintech

Leave a Reply

Your email address will not be published. Required fields are marked *