P2P lending has brought in disruptive changes in the global financial services industry. At a time when traditional banks are cautiously treading the path of lending, given the stringency in regulations, hedge funds and fintechs have come forward to fill this gap. Unconventional data sources for credit assessment (such as social networking profiles of customers), coupled with the power of digital technologies like Big Data and analytics, allow these niche firms to create a new channel of financial intermediation one that caters to underserved segments, such as customers with thin credit bureau profiles or low credit scores.
P2P lending is touted to be the biggest competition to traditional banks in the run up to 2020. The evolving financial environment has resulted in the emergence of P2P lending platforms, such as Lending Club and Prosper Marketplace Inc., across the globe. The Indian financial services industry is no different. Industry news suggests that India currently has some 30 startups in this space. In the wake of rapid mushrooming of niche firms and startups, the Reserve Bank of India (RBI) published a consultation paper in April 2016 seeking public information to develop a regulatory mechanism for P2P lending.
So, what has the RBI proposed?
The RBI is of the view that effective regulations will promote the growth of this alternative finance channel, and drive predictability and transparency, making it easy to monitor and introduce course corrections if required. Summarizing the key points in RBIs proposition:
- P2P lenders will be categorized as Non-Banking Finance Corporations (NBFCs), and registered as financial intermediaries. They will not be permitted to guarantee fixed rates of return to investors. This is to check financial scamsters from luring less sophisticated investors. P2P lenders may be allowed to publish credit assessment scores of borrowers on their portals.
- The funds lent by investors must be routed directly to borrowers, and not through the P2P lender.
- P2P lending firms will need a minimum capital requirement of INR 20 million (nearly USD 300,000) to ensure that the promoters of these portals have sufficient stake in the business. It is worth noting here that since P2P lenders are merely financial intermediaries and do not lend their own capital, this requirement is not for capital adequacy norms, but to discourage fly-by-night operators.
- There will be a limit on the maximum exposure an individual investor can take on a single borrower or segment, in order to safeguard less perceptive investors lured by high returns.
What has been the industrys reaction?
Financial services firms in India have welcomed RBIs norms, believing they will bring in the much-needed transparency to this hitherto unregulated sector, and promote structured development of the P2P lending space. However, some promoters of P2P lending portals have expressed reservations about the minimum capital requirement, saying it would impede the emergence of new ventures since firms will be forced to raise capital at a very nascent stage.
Our take on the situation
We welcome RBIs consultation paper and hope that this proposal will encourage investors to liberally engage with P2P lenders. And since RBI-regulated institutions enjoy higher public confidence, regulating this space will be a growth driver. Having said that, we feel some aspects need further clarifications, which are:
- Should P2P lenders be allowed to use alternative data sources such as social media profiles, web analytics, and mobiles wallets for credit assessment? Though these sources are being used internationally for credit evaluation, some regulators (like the US Treasury Department) have expressed concerns on their efficacy. Therefore, the RBI will need to examine how the loans approved using such sources will perform across the full credit cycle.
- Will P2P lenders be expected to report account behavior to credit bureaus? Given that the proposed regulatory architecture for P2P lenders will be on the lines of those for NBFCs, we recommend there should be parity.
- P2P lending is a participatory form of lending. For example, a borrower with a requirement of INR 100,000 may be funded by five different lenders. As per the regulations, funds transferred from each lender must flow directly to the borrower. This implies repayments need to flow back the same way, thus requiring multiple payment transactions. We recommend relaxation on this norm by allowing online lenders to aggregate and route payments, or alternatively, use escrow mechanisms (as suggested by T.V. Mohandas Pai, a financial expert) to ensure transactions do not become too complicated.
- Since P2P platforms will not be involved in the disbursement and repayment aspects of a loan, how will loan defaults be identified? Will lenders be required to notify the P2P platform in the event of a default? This can be addressed if repayments are routed through escrow accounts held by the lending platform.
To conclude, we feel the RBI has assumed a judicious stance in its regulations around P2P lending. While the minimum capital requirement may seem a little on the higher end, it will help create an entry threshold that will encourage P2P platforms to invest in risk management systems and operations. This is particularly important for the Indian financial market given the recent experiences with various Ponzi schemes such as the Saradha scam.