In October 2017, Umesh Rathi, 48 years, salaried person residing in Indore needed Rs. 5 lakh for home renovation. He applied for credit line loan from a fintech organization using mobile handset instead of traditional method of applying for a personal loan at banks. A credit line is a pre-approved credit provided to borrower wherein a person can withdraw a desired amount of credit periodically within a sanctioned limit as per requirements.
For instance, for home renovation lump sum Rs. 5 lakh was not immediately required by Rathi. So, he opted for a credit line facility wherein he opted to consume only Rs 3 lakh, to begin with. The interest that got kicked in first was just on Rs. 3 lakh of Rs. 5 lakh sanctioned by fintech lender.
He borrowed the remaining Rs. 2 lakh in February 2018 from the same approved credit line. If he had taken a personal loan of Rs. 5 lakh from a bank the option of borrowing in parts would not be available, and he would end up paying interest on the entire amount borrowed. Thanks to flexibility and financial benefits provided by digital lending platforms which are available at the finger tips for millennials disposal.
Collaborative Digital Lending
Consumer lending has typically fallen into two camps: (1) a traditional face to face interview (coupled with piles of paper forms to be fill up) and (2) highly automated credit card lending. Both methods are biased towards institutional needs and are coupled with high overhead. In the case of face to face lending, there are high labour and processing costs. In the case of credit cards, high interest rates are charged to compensate for inefficiencies, those who cannot pay, and to cover fraudulent activity. Neither method is attractive for credit worthy consumers who want an unsecured loan at a competitive rate. P2P lending may change all of that.
Peer-to-peer (P2P) lending platforms are online marketplaces bringing together borrowers and lenders/investors, and offering quick, low cost, technology driven solutions. P2P lending permits individuals to borrow as well as lend without the need of financial institutions or banks as intermediaries. P2P lending represents a new and potentially disruptive force in consumer lending and investment. It offers not just the promise of a better experience for borrowers, but a more efficient platform for investors as well. Its recognition and approval by various regulators around the world legitimizes the fledgling industry.
P2P lending brings the promise of a better win-win model that empowers both borrowers and investors. This is accomplished by providing a highly automated, socially networked internet platform that outsources the final underwriting decisions to the online community itself. That’s the breakthrough innovation. The market determines the interest rate of a loan – not an institution.
Marketplace Lending Platforms
P2P platforms employ innovative credit modeling and underwriting for lending, incorporating a variety of data sets (beyond credit scores) to target a wide set of potential customers, benefiting even those borrowers rejected by the traditional bank credit scoring system. For investors, P2P platforms offer automated loan selection features, where predefined criteria can be set by investors for loans they intend to purchase. The flexibility to invest up to 100% of capital, also exists. The P2P platform’s key strength lies in its simplified lending process through an online interface. While many features of the platform benefit borrowers, the investor also gains from the wide acceptance of the platform. Key features include: Quick check of interest rates online by providing some basic information regarding income, credit score, etc. on the P2P website, real-time updates of the approval and funding process, after approval, the borrower can quickly access the percentage of loan that has been funded.
Lenders / Investors
P2P lenders are considered investors. They will be investing small amounts of capital in many loans. Small accredited investors and large institutions alike stand to gain from a more efficient lending model that is possible with P2P lending. That’s the attraction. Higher returns, transparency, diversification across pool of borrowers, additional asset class etc. are the benefits relished by platform investors.
P2P lending allows credit worthy borrowers to tell their own story. They can describe their need, propose a suitable interest rate, and rationalize their credit history as required. As an example, borrowers with high credit card debt could (or should) be looking to pay down that amount with a lower interest rate loan. This is an ideal problem for P2P lending to solve. If the borrower has a good credit rating the P2P lending market may be able to offer dramatically lower lending rates. Faster processing, secure, transparent, confidential, convenience, superior experience are the main attraction for new age millennial borrowers.
The Reserve Bank of India (RBI) regulates P2P lending platforms to protect the interest of lenders and borrowers. In October 2017, RBI made it mandatory for all P2P companies existing to apply for a license to continue as a P2P platform. All new entrants had to get a provisional NBFC-P2P license from RBI to start operations in this space. RBI has maintained a cap on lenders and borrowers on the P2P platform; any lender cannot invest more than Rs. 10 lakh across all P2P platforms. Similarly, a borrower cannot borrow more than Rs. 10 lakh across P2P platforms. A lender cannot lend more than Rs. 50,000 to the same borrower across P2P platforms, at any point in time.
Various non- conventional forms of lending emerged out of which peer to peer lending or marketplace lending is one which started as a relatively simple system for facilitating loans between individuals online. P2P Lending has gained a solid traction in the Western market and it would be a matter of time before it sets a solid foot in India as well. However, the highly regulated market in India would make things time consuming. Having said so, P2P lending would definitely provide a mechanism enabling lenders and borrowers mutually strike a beneficial deal. Peer to peer loans are the easiest to avail with justified interest rates. P2P lending also enables investors earn a profitable margin by investing in credit worthy borrowers. Today these loans are purchased by large investors like banks, hedge funds and wealth management firms. The entry of these investors has motivated a growth of startups and other actors dedicated to advising investors, performing loan data analysis, and automating the investment process. P2P platforms in India are prone to attract only higher risk borrowers. This combined with the fact that individual lenders have limited risk-assessment tools available to them results in sub-optimal risk adjusted returns for lenders.
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